How invoice factoring could help your business

Invoice factoring allows businesses to access funds tied up in unpaid invoices.

Here’s how it works, and which businesses can benefit most from this type of funding.

Key takeaways

• Invoice factoring typically lets you borrow up to 95% of the value of your customer invoices

• You can receive the funds within 24 to 48 hours

• The invoice factoring provider collects the invoice payments from your customers on your behalf, allowing you to focus on running your business

• One of the biggest benefits of invoice factoring is that it can quickly improve your cash flow

• It’s best suited to B2B companies that invoice larger customers

• You can apply for it even if you have poor credit

What is invoice factoring? 

Invoice factoring is a type of invoice finance that enables you to sell customer invoices to a finance provider at a discount in return for quick access to cash. It uses your business’s unpaid invoices as collateral. 

Invoice factoring can suit businesses that have payment terms of between 30 and 90 days as it allows them to access the cash tied up in unpaid invoices a lot sooner. This can help to cover unexpected expenses or deal with cash flow shortages. 

Read more:

• How to get funding for a business

• Types of business loans explained

How does invoice factoring work?

If you apply for invoice factoring, the finance provider advances you up to 95% of the value of your invoices within 24 to 48 hours.

It works in the following way:

• You provide goods or services to your customers as usual

• You invoice your customers and then send these invoices to an invoice factoring provider

• Once the provider verifies the invoices, it transfers up to 95% of their value to you

• The provider collects payment from your customers

• After deducting its fee, the provider pays you the remaining balance

Invoice factoring example

Your company sells customer invoices worth £10,000 to a factoring company, in exchange for 90% of the value (£9,000).

The factoring provider collects the full £10,000 payment from your customers and takes off its £500 fee. The provider pays you the remaining balance (£500), meaning your company ends up with £9,500 of the original £10,000.

What is the difference between invoice factoring and invoice discounting? 

Invoice factoring and invoice discounting are both types of invoice finance that let you access up to 95% of the value of your customers’ invoices. However, there are key differences between the two.

With invoice factoring, the factoring provider is responsible for following up on customer invoices and collecting payment. This can save you time and hassle, allowing you to focus on running your business. However, it also means your customers will know you’re using a factoring provider, and fees are usually higher.

By contrast, with invoice discounting, you are responsible for chasing and collecting invoice payments from your customers. You repay the lender, but keep the portion of your invoice that wasn’t part of the invoice finance agreement, minus fees.

Invoice discounting is usually a cheaper option, and your customers won’t know you’re using a discounting provider. However, smaller businesses may find it harder to qualify, as the lender has less control over payment collection, which increases their risk.

How much does invoice factoring cost?

The invoice factoring fee is typically between 1% and 5% of the invoice amount per month. However, the exact fee depends on several factors, including the provider and the number and value of the invoices. Customer creditworthiness and your industry also play a role.

You may also need to pay a service fee of around 0.5% to 2% of your company’s total revenue, and some lenders charge an administration fee on top. This makes it essential to shop around and compare invoice factoring providers carefully, comparing the total cost, including service and administration fees.

Types of invoice factoring

There are several types of invoice factoring, outlined below:

• Recourse factoring: The most common type of invoice factoring. If your customers do not pay their invoices, you remain responsible for the non-payment, and may have to buy back the invoice from the lender later

• Non-recourse factoring: The lender takes on most of the risk of non-payment. If a customer fails to pay, the lender is liable for the loss, not your business. However, this option is usually more expensive

• Spot factoring: Allows you to sell one or a small number of invoices to a lender in return for credit. This can be useful if you have a particularly large invoice, for example. You then manage the rest of your invoices as usual

• Whole ledger factoring: The opposite of spot factoring. Instead of selecting specific invoices, you sell all outstanding invoices to a lender

Advantages and disadvantages of invoice factoring

Before deciding whether invoice factoring is right for your business, consider the pros and cons.

Pros

• Improved cash flow: One of the biggest benefits of invoice factoring is that it can quickly boost your cash flow. Rather than waiting weeks or months for payments, you receive cash almost immediately, which could help you seize new business opportunities

• Easier to obtain: Invoice factoring is typically much easier to apply for than a traditional bank loan, with payouts usually within 24 to 48 hours

• Saves you time: The invoice factoring provider follows up on payments on your behalf, allowing you to focus on running your business

• Flexibility: You can choose to sell all your invoices or just a few.

• No additional collateral required: Your invoices act as security, so no further collateral is needed

Cons

• Can harm customer relationships: Customers will know you are using a factoring provider, and if the provider is too aggressive in chasing payments, it may put them off working with you again. They may also assume your business is struggling financially

• Fees can be high: Invoice factoring is generally more expensive than invoice discounting. Costs may be higher if a lender considers your customers high risk and less likely to pay

• You could be held accountable: If you have a recourse arrangement and a customer doesn’t pay, you are responsible for repaying the lender, which could leave your business out of pocket

• Not suitable for businesses with few customers: Lenders prefer to spread risk across multiple customers, so businesses with only a few clients may not qualify

• You may have to commit to a contract: Some lenders require contracts of one or two years, or even longer. Consider whether you are comfortable with this commitment

How invoice factoring can help small businesses

Invoice factoring can be particularly useful if you have many outstanding high-value invoices but lack the resources to chase overdue payments. It allows you to focus on other aspects of running your business while someone else collects payments on your behalf.

Moreover, it can quickly boost your cash flow, improving your business’s chances of survival and enabling you to explore new opportunities, such as expanding your premises or launching new products, that might otherwise be unaffordable. 

Who offers invoice factoring?

A range of invoice factoring providers are available, including specialist online companies, banks, and other financial institutions.

It’s worth checking whether your provider is a member of UK Finance’s Invoice Finance and Asset-Based Lending framework, as this ensures they follow a code of conduct and meet specific standards when offering finance. 

When comparing invoice factoring providers, consider:

• The percentage of the invoice value you can receive (usually between 80% and 95%)

• The fees involved

• How quickly you will receive the funds

• Whether you need to commit to a contract

Is invoice factoring right for your business? 

Invoice factoring is best suited to businesses that trade with other businesses (B2B), rather than individual consumers (B2C). That’s not to say you can’t apply for invoice factoring as a B2C business, but you could receive less finance. 

It’s also more suitable for businesses that invoice larger companies with payment terms of between 30 and 90 days. 

Invoice factoring may be worth considering if you have few or no assets to borrow against, limiting other financing options. Additionally, businesses with poor credit scores or limited credit histories may find it easier to qualify for invoice factoring than for a traditional business loan. That’s because factoring providers typically focus more on your clients’ creditworthiness than on your business credit score. 

Types of businesses that might benefit from invoice factoring include those working in the following industries:

• Construction

• Manufacturing

• Haulage

• Recruitment 

• Security

What are the alternatives to invoice factoring?

If you want to avoid invoice finance completely, you could consider the following sources of funding: 

• Merchant cash advance: This is a short-term funding option for businesses that accept debit and credit card payments. You receive a cash lump sum based on future card sales and repay this as a percentage of your customers’ card payments, plus fees

• Asset finance: This is for businesses requiring access to equipment, machinery or vehicles but can’t afford to pay for them upfront. It enables you to pay for these assets in instalments. At the end of the agreement, you may own the asset outright, return it or renew the agreement

• Business loan: Provides a lump sum of cash that you repay in fixed monthly instalments over time, with interest added 

• Business credit card: A more flexible borrowing option, giving you access to funds up to your set credit limit whenever needed. You repay the amount borrowed in flexible monthly instalments 

• Business line of credit: Another flexible borrowing option, allowing you to borrow up to your set limit whenever required, either as a lump sum or in smaller amounts. You only pay interest on the amount borrowed

• Business overdraft: If you have a business bank account, you may be able to apply for an overdraft. However, interest rates can be high