What is invoice financing?

If you sell your goods or services to other businesses on credit, invoice financing offers a flexible method of borrowing using the value of your sales ledger to release regular sums of working capital.

This type of finance provides an attractive alternative to traditional bank lending due to the speed with which it can be accessed, and the fact that acceptance doesn’t rely on a good business credit rating.

Invoice financing offers significant benefits to a company’s cash flow, and is a useful resource if your business suffers excessive bad debts or delays in receiving debtor payments.

So how does invoice financing work, and could it be suitable for your business?

How does invoice financing work in general?

• You invoice your customers and send the details of each invoice to the financier
• The finance provider releases an agreed percentage of the invoice amount, usually within 48 hours
• You receive this agreed portion of the invoice amount before your clients make the payment
• Depending on the type of invoice finance you use, you or your invoice financier collect payment
• The remaining balance of each invoice becomes available when your customer pays in full

Invoice finance providers typically offer between 85% and 95% of the value of each invoice - this can vary according to the type of business you run and the industry in which you operate. The financing contract has no fixed duration, and your access to cash is limited only by the number of credit sales you make.

Different types of invoice finance

There are two types of invoice finance – factoring and invoice discounting. Although the lending principals are the same for each method, there are also clear differences.

Factoring

Invoice factoring involves the purchase of your sales ledger by the financier. The factoring company manages your credit control facility, including chasing payments, which means your customers will know about the arrangement as they pay the factor rather than your company. The factor also credit checks your customers, reducing the potential for late payers and bad debts.

Invoice discounting

Invoice discounting is very similar to factoring, but it doesn’t involve handing over control of your sales ledger to the financier. You remain responsible for chasing payments, and customers aren’t generally aware that you’re securing additional finance in this way. 

When is invoice financing a good option?

If your business depends on regular cash flow, invoice finance can be a good borrowing option and offers you peace of mind that bills will be paid. Invoice discounting may be more suited to large companies with a dedicated credit control department, and effective systems for chasing payments.

For some smaller companies, chasing overdue payments represents an administrative burden and takes focus away from making sales and providing high levels of customer service. In these cases, factoring might be a better option.  

Industries that commonly use invoice finance include construction, manufacturing, logistics, recruitment, publishing, and business services. Overall, it allows them greater agility in a marketplace that can change quickly, and helps them overcome the risks associated with late payment.

Benefits of invoice finance

• Your company receives regular cash injections each month
• Chasing payments is no longer necessary if you use factoring
• It’s a flexible way to finance your business
• Decisions are generally made quickly by lenders
• Invoice discounting is a confidential arrangement so your customers won’t be aware you’re using the sales ledger to fund your business

Are there any disadvantages to invoice financing?

• Monthly fees are charged by lenders, potentially including a management fee for looking after your sales ledger, and a discount fee that works in a similar way to the interest you pay on a loan.
• If you decide to cancel the arrangement at any point you would need to plan the transition well in advance to avoid negative cash flow.
• The nature of factoring means you have no control over the relationship between the company and its customers.

For more information on invoice financing and how it could benefit your business, as well as information on other commercial funding options, please call Begbies Traynor for a free consultation. We have contacts with over 50 alternative financiers around the UK, and can advise on the best form of finance for your business.