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Invoice financing – how can you use it as business finance?

3-minute read

Catriona Smith

6 July 2022

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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 regularly send invoices for work you’ve done, you know that chasing overdue invoices and managing your finances while you wait for payment can be challenging.

And depending on your payment terms, it might be 30 days (or sometimes up to 90 days) before a client pays you after you’ve issued the invoice.

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

What is invoice finance?

Invoice financing 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 a short-term business finance option, plugging the gap between invoice payments and boosting your cash flow.

As an alternative to getting a business loan, it can be a quicker way to access cash. The money can sometimes be available within 24 hours.

But invoice financing isn’t without risk in the long-term, so you should think about whether it’s right for you and your business.

How does invoice financing work?

There are two types of invoice financing. Here’s an overview of invoice discounting vs factoring:

1. What is 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. What is 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).

What are invoice financing costs?

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 1.5-5 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)

Invoice finance 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

Invoice finance 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

Resources to help you with business finance

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

We also have templates to help you create a self-employed budget and a balance sheet.

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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