Invoice finance releases capital from unpaid invoices. A lender provides you with a loan based on the balance of debt that is owed to your company. When the payment has been settled with your customer, you receive the rest of the balance, minus a small fee. Unlike overdrafts or loans, this sort of funding grows in line with business turnover, working as a flexible solution to regulate your cash flow. Releasing money from invoices can provide a vital injection to cash flow, and free up money for other things like purchasing new stock. Read on to find out more about how invoice finance could benefit your business.
In this guide:
What are the advantages of invoice finance?
- It is an incredibly secure form of finance. A sales ledger is used to secure access to funds. This means that as your business grows, so does the amount of funding that can be made available to you.
- You receive an immediate cash injection, and from thereon have an ongoing funding source that's directly linked to your current sales. As your business grows, so does the amount of working capital that your invoice financier can make available.
- You can improve your profitability. Paying suppliers early allows you to buy in larger volumes, taking advantage of any large volume discounts available.
- In the UK, an extensive credit history isn't needed. It is the sales ledger of the business that is used to secure access to funds.
- You cut out the process of waiting for approval on a loan - it is a faster and more flexible way of securing finance.
Are there any disadvantages to invoice financing?
- You don't receive the full value of your invoices, as your factoring company takes a small fee plus interest out of the value of each one.
- The actions of a factoring company could damage your relationship with your clients, as the client might view them as a sort of debt collector.
- You may become too reliant on invoice finance, preventing you from fixing the issues at hand that are causing your cash flow issues.
- Factoring companies won't deal with really old invoices.
Who can use invoice finance?
Some sectors are more suited to invoice finance than others. For example, sectors where the principal asset is intangible, like services, might benefit from invoice finance as they have few physical assets to raise money against. Invoice finance is normally used by smaller businesses that aren't likely to have their own in-house credit departments.
Invoice finance is ideal for:
- Firms that are growing fast but lack the resources and cash flow to fund their expansion plans.
- Start-up business with a turnover of at least £50,000 per year.
- Larger businesses that want to fund some major transactions, such as mergers and acquisitions.
- Businesses that are experiencing cash flow difficulties or have been the victim of late payments.
How does invoice financing work?
When using invoice financing, your business sells on its invoices to a debt collection company. This company then collect sales invoices on your behalf. Most businesses that use invoice finance do so to improve cash flow, but it also removes the administrative burden of managing accounts, and the inconvenience of chasing up clients who don't pay invoices on time.
Invoice finance is also known as 'invoice factoring'. There are many companies that offer factoring services, including major banks. But if you're considering using invoice finance, then you need to know that it is a long-term and legally binding commitment. You should check all agreements thoroughly before signing anything.
Once you've signed up for invoice financing services, you should receive up to 95% of the invoice value within a day of passing the invoice to your factoring company. Your customer then pays the invoice to the factoring agency, and the agency passes the balance over to you, taking away their fees and any interest that applies.
How much does factoring cost?
Instead of charging interest and arrangement fees that apply to a bank loan, factoring fees consist of two parts:
- A service fee covers the day-to-day servicing of your purchase ledger. This can be around 0.5% to 3% of your turnover.
- Interest is charged against the value of each invoice, which is normally at a fixed rate above the factoring.
What about invoice discounting?
Invoice discounting is another way that you can generate instant cash from your invoices. The difference here is that you retain ownership of the invoices. Here's how it works:
- You invoice your customers as usual, and then send these invoices on to your finance company.
- The finance company then decide on a percentage of the invoice that they will lend you. They advance these funds to you as a line of credit or a lump sum, freeing up cash flow.
- Your customers pay you when their invoice is due, and you then use this money to pay the finance company back, including any fees and interest that they have charged you.
As with invoice discounting you are still the one whom is dealing with your customer, you don't risk damaging your relationship with your client - there's no potential for them to see your finance company as a 'debt collector'. However, there is one way that you can eliminate this risk and still use invoice finance...
How does confidential invoice discounting work?
With confidential invoice discounting, your customers are completely unaware that you are using a third party. Only the invoice finance provider and the business in question are aware of the arrangement. This means that you can pressure your customers to pay their invoices in good time, all the while being assured that you already have access to the invoice cash.
When a business raises an invoice to their debtor, they also send along a copy to their invoice finance provider. Once they receive it, the invoice finance provider releases a cash advance to the business. The amount of cash released can be up to 90% of the invoice value, depending on the agreement between the business and its provider.
When the customer pays their invoice, it is paid into an account which holds the name of the company but is under the control of the invoice finance provider. This triggers the invoice finance provider to release the outstanding 10% of the invoice (minus their agreed fees) to the business.