- >
- Business>
- Business loans>
- Invoice finance explained: A simple guide for SMEs and startups
What is invoice finance?
Find out how your business could unlock up to 95% of your unpaid invoices in advance.
Invoice finance is a short-term funding option that can provide your business with a quick cash injection and help it maintain a healthy cash flow. Rather than waiting weeks or months to receive your customer invoice payments, invoice finance enables you to access the money you’re owed in advance.
Key takeaways
Invoice finance typically lets you borrow up to 95% of the value of your customers’ invoices
You are usually advanced the funds within 24 to 48 hours
The three main types of invoice finance are invoice factoring, invoice discounting and selective invoice finance
With invoice factoring, the lender takes care of chasing and collecting invoice payments, while with invoice discounting, it’s up to you to collect payments from your customers
You typically pay higher fees with invoice factoring
These unsecured and secured loans could help you grow your business, cover running costs or even fund a new company.
How does invoice finance work?
Invoice finance is a type of secured business lending that allows you to borrow money by using your business’s unpaid invoices as collateral. An invoice finance company gives you access to a percentage of the value of those invoices, and you repay this sum once your customers have paid their invoices.
The process works as follows:
You provide the goods or services to your customers and invoice them
You send these invoices to an invoice finance provider (the lender)
The lender provides you with a percentage of the value of those invoices, usually between 80% and 95%, within 24 to 48 hours
Depending on the type of invoice finance you use, either you collect the funds from your customers and repay the lender, or the lender collects the cash on your behalf, and pays you the remaining balance.
The lender deducts its fees.
Types of invoice financing
The three main types of invoice financing are invoice factoring, invoice discounting and selective invoice finance.
Invoice factoring
With invoice factoring, the lender advances you up to 95% of the value of your invoices and manages your sales ledger. This means the lender collects payment for your invoices directly from your customers. This allows you to focus on your business, rather than spend valuable time chasing payments. But it also means your customers know you are using a factoring provider.
Once the lender collects the payment from your customers, it repays you the remaining balance, minus any fees. These are usually higher compared to other types of invoice finance. However, it can be easier for small or early-stage companies to qualify for invoice factoring.
Invoice discounting
In the case of invoice discounting, the lender advances you up to 95% of the value of your invoices, but it’s up to you to collect the invoice payments from your customers. You then repay this money to the lender, retaining the portion of your invoice that wasn’t part of the invoice finance agreement, minus fees.
Generally, invoice discounting comes with lower fees and customers won’t know that you’re using an invoice discounting provider.
Selective invoice finance
With selective invoice finance, you can choose specific customers whose invoices you’ll borrow against. Spot factoring means selling individual invoices to a lender in return for credit - whether that’s just one invoice or a handful. Your invoicing process for other customers and bills remains unchanged.
Note that these methods may not provide finance on an ongoing basis, so they are best suited to businesses that have the occasional need to boost cash flow.
Advantages of invoice finance
There are several advantages to using invoice finance:
You don’t need additional collateral because the invoices act as security
You can get immediate access to cash from invoices
With invoice factoring, the lender chases payments, so you don’t have to
With invoice discounting, clients don’t know that you are borrowing
Invoice finance provides a flexible way to borrow funds
As your business grows, you can access more funds to enhance your cash flow
Disadvantages of invoice finance
It’s also important to be aware of the downsides of invoice finance:
Fees can be higher than other financing options
With invoice factoring, customers usually know you’re using a factoring provider, which can affect perceptions of your business
Depending on your agreement with the provider, you may be held accountable if your customers don’t pay their invoices
Some lenders require a minimum contract length
What are the costs of invoice finance?
Invoice finance costs can vary considerably depending on the lender you use. You typically need to pay an interest fee of around 1.5% to 3% above the Bank of England base rate, although this can be higher for invoice factoring.
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 initial arrangement fee to set up the invoice finance facility.
Costs can depend on the size of your business, the number of invoices and their value, and the creditworthiness of your customers. Make sure you shop around and compare quotes from a range of providers to find the best deal.
Who is eligible for invoice finance?
You’re more likely to qualify for invoice finance if you’re a business that trades with other businesses (B2B), rather than individual consumers (B2C). Although you can still apply for invoice finance if you’re a B2C business, you could receive less finance.
Your business should also have a robust trading history so that lenders can see you have a track record of issuing invoices to customers. Lenders need to see detailed and accurate financial statements to support this.
Additionally, lenders may require you to meet a minimum annual turnover requirement, which is usually higher for invoice discounting. Some lenders may refuse to let you borrow if your customers have particularly long payment terms, such as over 90 days.
What type of business is invoice finance best for?
Invoice finance could suit your business when your customers have payment terms of between 30 and 90 days and you have fluctuating cash flow. It’s generally better suited to businesses that invoice larger companies.
If you’re struggling to get a traditional business loan due to a limited business credit history or low credit score, you may find it easier to qualify for invoice finance.
How to choose the right invoice finance lender
When comparing invoice finance lenders, it’s worth considering the following:
Fees: Find out what fees you can expect to pay for each lender.
Percentage of invoice value: How much do you receive upfront? This is generally between 80% and 95%, but it may be more or less than this.
Speed of funds: Check how quickly you receive your funds - this is usually either within 24 or 48 hours.
Length of commitment: Find out whether you need to tie into a fixed-term contract and if so, for how long. This could be 12 or 24 months.
Number of invoices: Check whether you need to finance all your invoices or only some of them.
Alternatives to invoice finance
If you’re not sure invoice finance is the right solution for your business, there are other sources of funding to consider:
Merchant cash advance
A merchant cash advance is a short-term funding option for businesses that accept debit and credit card payments. Your business receives a lump sum based on your future card sales and you then repay this as a percentage of your customers’ card payments, with fees.
Asset finance
Asset finance can suit businesses that need access to equipment, machinery or vehicles, but can’t afford the upfront costs. Instead, you pay for these items in instalments and, depending on the agreement type, at the end of the term, you might own the asset outright, return it, or have options to purchase it or renew it.
Business overdraft
If you open a business bank account, you may have access to a business overdraft. This can provide a flexible way to borrow the funds you need. However, interest rates can be high so it shouldn’t used for long-term borrowing.
Business lines of credit
A business line of credit provides flexible access to funds as you need them. You can borrow up to your set limit and you only pay interest on the amount withdrawn.
Business loans
A business loan enables you to borrow a lump sum of cash that you then repay in fixed monthly instalments over a set term, with interest added. This could enable you to pay bills, employee salaries or expand your business.
Business credit card
A business credit card is another flexible borrowing option and can be ideal for managing cash flow. You can borrow up to your set credit limit and repay the amount borrowed in flexible monthly instalments, with interest added.
FAQs
What’s the difference between invoice discounting and factoring?
The key difference between invoice discounting and factoring lies in who collects your customers’ invoices.
With invoice discounting, you collect the invoices as usual, so your customers are unlikely to know you’re using invoice finance.
With invoice factoring, the lender chases and collects your customer invoices. This saves you the hassle of doing it yourself, but your customers are usually aware you’re using a factoring provider.
Is accounts receivable financing the same as invoice financing?
Yes, accounts receivable financing and invoice financing are the same thing. Accounts receivable refers to all the money a company is due.
How is invoice finance different from traditional bank loans?
One of the biggest differences between invoice finance and a traditional bank loan is the length of time it takes to receive your funds. With invoice finance, this can be within 24 hours, whereas a traditional bank loan can take several days or weeks to approve.
Repayment terms also differ. With invoice finance, you repay the loan once your customers have paid their invoices, while traditional loans require you to make fixed instalments each month.
But on the other hand, bank loans usually have longer repayment terms and lower interest rates.
What is the typical interest rate for invoice finance?
You can generally expect to pay between 1.5% and 3% above the base rate for invoice finance, although rates can be higher for invoice factoring.
Do my customers know I’m using invoice finance?
That depends. Your customers are unlikely to know you’re using invoice finance if you’ve opted for invoice discounting, as it remains your business’ responsibility to chase and collect customer payments.
However, if you choose invoice factoring, the lender collects your customer invoice payments on your behalf, and therefore your customers are likely to be aware you’re using invoice finance.
What happens if my customer doesn’t pay their invoice?
Again, this depends on the type of invoice finance you’ve used. With invoice factoring, the lender usually takes over credit control and carries out credit checks on your customers. If you have a non-recourse arrangement and a customer doesn’t pay, you won’t have to pay back the money yourself and the lender is liable for the losses incurred.
On the other hand, if you have opted for invoice discounting, it’s your responsibility to chase invoices and you must also vet your customers. If an invoice goes unpaid, you still need to repay the lender. Invoice discounting is more readily available to larger companies with reliable customers.
How quickly can I access funds with invoice finance?
Generally, you can expect to access your invoice finance funds within 24 to 48 hours, depending on the lender.
Can I get invoice finance with bad credit?
Yes, you might be able to get invoice finance with bad credit. Although lenders may look at your business’ credit history, they also consider other factors such as how long you’ve been trading and the size of your invoices. Lenders often focus on your clients’ creditworthiness rather than your business credit score, particularly for invoice factoring.
About Rachel Wait
Rachel has spent the majority of her career writing about personal finance for leading price comparison sites and the national press, including for the Mail on Sunday, The Observer, The Spectator, the Evening Standard, Forbes UK and The Sun.