Business Knowledge Hub

Invoice financing: everything you need to know

Want to know more about invoice financing and whether it is a viable finance option for your business? We cover the key issues to help you decide.

Accountant's hands holding invoice at work desk

What is invoice financing?

As a business owner, you may find that your cash flow sometimes suffers as a result of late payment of invoices. This is a common problem and a large number of small business owners opt to use a form of invoice financing to allow them to access cash from customers immediately.

Invoice financing is a catch-all term used to describe the process whereby a provider ‘buys’ unpaid invoices from businesses for a fee and/or a percentage of the total invoice value. In some cases they will then also obtain the money owed from the debtor.

There are a number of different types of invoice financing, which it’s worth looking at in detail to understand which could be of most use to your business.

The growing demand for invoice financing

According to figures released at the end of 2017 by UK Finance, the use of invoice financing reached record highs in the final quarter of last year, with a total value of £22 billion. This is a 13 per cent increase on the same period in 2016.

"There is increasing understanding amongst businesses of all sizes of how invoice finance and asset-based lending can support them as they grow."

Matthew Davies, UK Finance

It’s clear that small businesses can benefit from the use of invoice financing, particularly when the economy is strong. However, many business owners are less keen to choose this source of finance when the economy looks less robust. Indeed, things look rosy for invoice financing now, but there are already concerns cropping up that this might not continue, depending on just how the UK economy fares post-Brexit

There are other obstacles in the way of using invoice financing when small businesses work with larger organisations. ‘Ban on Assignment’ clauses are sometimes used by larger businesses to limit their smaller suppliers’ access to invoice financing. To address this, there is growing pressure on the government to resurrect the 'Business Contract Terms (Assignment of Receivables) Regulations 2017’ that was tabled and later withdrawn in late 2017.

Introducing the regulation would require a time-consuming examination of the impact of the legislation on commerce in general, but small businesses and invoice finance providers are unlikely to drop calls for the regulation to be reconsidered.

When is invoice financing beneficial?

If you foresee cash flow problems for your business or are already suffering as a result of late payment of invoices, then invoice financing could be worth considering. Having access to most or all of the cash owed to you by your customers means greater flexibility, predictable income and easier financial planning.

Some options can involve a complete outsourcing of your sales ledger process, which would free up time for you to spend on other areas of your business.

Advantages to using invoice financing

  • Immediate access to cash owed by customers.
  • Greater access to working capital to invest in your business.
  • More predictable cash flow.
  • Easier to plan for the future.
  • More straightforward accounting.
  • Possibility of outsourcing all sales ledger activities.
  • Opens possibility of working with larger customers who want long payment terms (90 days for example).

Choosing the right type of invoice financing

There are three main types of invoice financing: 1. factoring, invoice discounting and invoice trading.

Factoring

This involves a business appointing an invoice financier to take complete control of its sales ledger operations. The financier will hand the business a percentage of the value of each invoice upfront before collecting the money owed by the each customer. When the cash is all received, the financier will pay the business the rest of the invoice value minus a fee and interest.

Advantages to factoring Disdvantages to factoring
  • Frees up time to spend on other business matters.
  • The financier will usually credit check your customers.
  • Reliable and timely access to the money customers owe you.
  • Your customers will know you are using a factoring service and this could reflect poorly on your reputation.
  • You will pay for the service.
  • Your customers may resent not being able to deal with you directly on financial matters.

Invoice discounting

This involves a business borrowing cash against the value of their unpaid invoices at an agreed percentage of the overall value. This doesn’t involve the financier providing sales ledger or debt collection services for the business. As well as keeping a percentage of the invoice value, the business will also pay a fee to the financier.

Advantages to invoice discounting Disdvantages to invoice discounting
  • It can be arranged confidentially so that customers do not know they are dealing with an invoice financing company.
  • Flexibility to borrow against invoices as and when you need to.
  • You will not get to keep the full value of the invoice.
  • You will still have to chase your own debtors for payment.

Invoice trading

This involves a business borrowing cash against the value of their unpaid invoices at an agreed percentage of the overall value. This doesn’t involve the financier providing sales ledger or debt collection services for the business. As well as keeping a percentage of the invoice value, the business will also pay a fee to the financier.

Advantages to invoice trading Disdvantages to invoice discounting
  • Allows you to work with individual investors rather than large institutions.
  • Flexible access to cash owed.
  • Particularly useful if you have one or two customers who insist on longer payment terms.
  • Customers will be aware you are using invoice financing, which could damage your reputation.
  • You will usually retain responsibility for your debt collection and sales ledger.
  • You won’t keep 100 per cent of the cash owed to you.

How to apply for invoice financing

In order to apply for invoice financing you will usually have to meet some strict criteria. Most will insist on a minimum annual turnover of at least £100,000, while many will ask for a minimum turnover of £500,000 or even £1 million.

You will need to run your company in the UK or Ireland and be registered with Companies House and you will need to sell goods or services to customers on credit terms.

Are you eligible for invoice financing?

  • Do you meet minimum turnover requirements?
  • Is your business registered with Companies House in the UK or Ireland?
  • Do you sell to commercial customers (not to members of the public?)
  • Do you sell on credit terms?
  • Do you have a strong credit history?

If you can answer ‘yes’ to the checklist in the box above and you decide to go ahead with this form of business financing, ensure you shop around for the best deals on invoice financing for small businesses.

There are huge variations in the fees and percentages charged by different providers so it’s worth spending some time researching your options.

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