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A guide to invoice finance

3-minute read

Catriona Smith

1 September 2021

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Invoice finance can be used to access cash quickly while you wait for customers to pay you. Whether you need to pay suppliers or employees, or reinvest to grow your business, invoice financing can be a quick way to boost cash flow.

If you’re regularly sending invoices for work you’ve done, you’ll be well aware of the challenges of chasing overdue invoices and managing your finances while you wait for payment. And depending on your payment terms, you could be waiting 30 days or sometimes up to 90 days for a client to pay you after work’s been completed.

Here’s how invoice financing can help your business manage cash flow.

What is invoice financing?

Invoice financing is a short-term way to plug the gap between invoice payments and boost your cash flow. It essentially allows you to sell your unpaid invoices to a third-party, who will then lend you up to 95 per cent of the value of those unpaid invoices up front.

It’s an alternative to getting a business loan, and can be a quicker way to access cash. However, invoice financing isn’t without risk in the long-term, so read on to understand more about whether it’s right for you and your business.

How does invoice financing work?

There are two types of invoice financing:

1. Invoice factoring

The lender will have control of chasing invoice payments and can credit check potential customers, giving you more time to focus on running your business. This does mean your customers will know you’re using a finance provider though, so make sure you’re happy with the lender’s approach.

Usually the lender will loan you 70 to 85 per cent of the invoice up front, and pay you the remaining amount (minus interest and fees) when the customer pays the invoice.

An example:

If you have an unpaid invoice for £200, you'll receive £140-£170 up front from the lender and then approximately £30-£60, minus any fees, once the invoice has been paid.

2. Invoice discounting

This is intended for businesses with higher turnover, offering them more control (but greater admin) as they’ll be responsible for chasing payment.

Here you can get an advance of up to 95 per cent of the invoice amount, with the rest paid (minus interest and fees) when the customer pays.

An example:

If you have an unpaid invoice for £500, you'll receive £475 up front and then the remaining £25, minus any fees, once the invoice has been paid.

Finance for individual invoices or customers

Another option is to use ‘select invoice finance’ or ‘spot factoring’. This allows you to select which invoices and customers you want funding for, so you only use the lender when you need to.

Select invoice finance – choose which customers you want to finance (for example, if you have a client that regularly fails to pay invoices on time).

Spot factoring – choose which invoices you want funding for (for example, a large project with expensive materials, or invoices with longer payment terms).

How much does invoice financing cost?

Be aware that there’s usually a monthly cost associated with invoice financing. Other costs to look out for include:

  • factor fees – this cost is for each invoice, normally 0.5-5 per cent of the invoice value
  • credit check fees – if your lender wants to carry out a background check on you and your customers, the cost ranges from 0.2 to 2.5 per cent of gross turnover
  • renewal fee – some companies charge a fee to renew your account at the end of a contract, but many in the UK don't
  • termination fee – if you have a contract with an invoice finance lender for a certain period of time, they might charge you if you end the contract earlier (this depends on the size of your invoice finance facility)

Benefits

Some of the advantages to using invoice finance include:

  • quick access to cash – you can be paid as soon as you send your invoice rather than waiting for your client to pay you (usually within one or two days)
  • no risk to assets – unlike a business loan, invoice financing isn’t a risk to your assets as the loan is based on outstanding invoices
  • opens up investment opportunities – if you’re a new company and want to grow your business more quickly, a cash injection based on unpaid invoices can help you invest and grow more quickly

Risks

If you’re considering invoice finance for your business, make sure you’re aware of some of the drawbacks and long-term implications, too:

  • your customers must be other businesses – invoice financing is restricted to invoices sent to other businesses rather than the general public
  • long-term costs – make sure you’re aware of the rate of interest, processing costs, and any hidden fees, as this can all add up over time
  • risk of damaging client relationships – if you use invoice factoring, you won’t be in control of collecting the invoice payments from your customers, the lender will. This could potentially damage the trust and relationship you have with your clients

Financial resources

You might also find it useful to check out our guides on how to apply for a business loan and how to increase profit.

Business finance is complicated, so you should speak to a financial advisor or invoice finance broker if you’re unsure about anything.

Is there anything else you’d like to know about invoice finance? Let us know in the comments.

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We create this content for general information purposes and it should not be taken as advice. Always take professional advice. Read our full disclaimer

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