With invoice finance, a business sells their unpaid invoices (accounts receivable), to a third party for a percentage of their value. The existing invoices serve as security for the lender, who then provides the borrower with a percentage of the outstanding invoices upfront, as a loan. This advance enables the business to leverage their sales ledger, increasing the cash moving through the company and injecting cash into their working capital.
Invoice financing is a flexible type of borrowing. As it bases itself on cash that’s due in soon, firms can grow their borrowing power as turnover increases. Invoice finance, otherwise known as debtor finance, is an umbrella term covering a range of asset-based financing facilities. There are two primary forms of invoice finance: invoice discounting and invoice factoring.
Invoice finance enables businesses to access cash upfront for unpaid invoices, instead of having to wait weeks or months for their customers to pay their bills. It’s can be a useful asset-based finance solution for any business struggling to bridge the gap between accounts payable and accounts receivable – in other words, cash in, and cash out.
Invoice Financing Process
Once the customers pay their invoices, the lender provides the remaining balance, minus their fee. Companies using invoice finance can get hold of their advance typically within 24-48 hours of creating an invoice, meaning they have a rolling cash flow throughout the month, rather than waiting for customers to pay within their 30-, 60- or even 90-day payment terms.
As a company grows, their invoice finance facility can grow to match, in some cases covering their entire sales ledger. This flexibility means that companies experience their growth tangibly and can continue to expand and invest as their turnover increases. Invoice finance can improve a company’s Working Capital Cycle (WCC), this is why debtor finance is also sometimes known as working capital finance.
Discounting and Factoring Products
Invoice Discounting
With invoice discounting, you still collect and manage your invoices yourself and deal with your customers directly. As soon as your complete work for a customer or fulfil an order, you send the invoices to your customers as usual, sending a copy to your lender at the same time. The lender deposits the agreed portion into your account, usually within 24-48 hours, and your customers pay your business as normal (with your business paying the lender once the customer has paid the invoice).
A major advantage of using invoice discounting is that you retain control over your sales ledger. You have the responsibility of interacting with customers and chasing late payment.
Invoice factoring
Invoice factoring differs from invoice discounting in that the lender assumes control over your sales ledger. Customers will be required to pay the lender directly, and it will be down to the finance provider to chase late payments. Some businesses favour this form of finance, as it frees up their time and resources to put towards other tasks and projects. However, it can damage your customer relations depending on how the lender handles customer service or chasing of payments in relation to invoices.
Invoice factoring tends to be more expensive than invoice discounting, as the lender takes on the work involved with maintaining your sales ledger. This control also means that many invoice factoring contracts are significantly longer than any you might have with invoice discounting (to offset the lenders fixed costs in setting up the facility). It’s more cost-effective for a company to assume a larger sales ledger, either with more clients or bigger invoices, or control your sales ledger over a longer period, to minimise their administration costs.
Businesses that Are Eligible
Your eligibility for invoice finance will depend on several factors. Mostly finance providers will want to verify how creditworthy your customers are and see information on the time frame of their payment terms as well as the size of their invoices.
Your eligibility will also depend on what type of invoice finance you choose. Some businesses may be more eligible for discounting rather than factoring, and the other way around. Invoice financing firms will typically based whether they’re willing to lend to you, the amount and the terms based on the following factors:
- Size and amount of invoices – The more invoices you want to release funds from, and the bigger they are, the lower your rate is likely to be. This is because it’s more cost-effective for a lender to set up a facility that you use regularly, or through which a lot of funds pass.
- Your industry – Some industries are risky by nature. Non-payment is a bigger problem in some sectors than others, and your credit protection charge will reflect this larger risk. This is particularly the case for non-recourse agreements.
- Your business background – In the case of invoice discounting, lenders rely on your credit control processes to receive payment. They will want to see how robust your payment collection strategy is and which processes and controls you have in place. – Lenders will also want to see evidence of your trading history. They want to know how reliable your customers are and see proof that they usually pay up, and pay on time. Almost always, the more creditworthy your customers, the lower rate you’ll pay.
How Quickly Can I Get Invoice Finance?
Invoice finance is quick and easy to set up. Most providers require only an online or telephone application and will approve your request within a few days. Once a facility is up and running, most lenders supply your advance within 24-48 hours of receiving an invoice.
Factoring Requires More Documentation
Factors generally require more documentation upfront than invoice discounting providers, as the lender is assuming more responsibility, and therefore liability, with regards to credit collection and control. If you are seeking a factoring facility, the lender will want to see a number of documents, including:
- a detailed list of your customers
- your finances for audit
- your sales ledger
- details of outstanding invoices to be funded.
In some cases, the factor will also require a written guarantee from the company director. It’s a good idea to have these documents ready before applying, as any missing paperwork can lead to significant delays.
Calculating Cost
Most invoice factoring and discounting agreements comprise of two primary fees, the service charge and the discount fee. It’s also worth noting on top of these fees, many contracts include additional fees.
Service fee
The first is the service fee, which equates to the cost of maintaining the facility. This fee goes towards the management of your account, and in the case of invoice factoring, the costs involved with collecting payment and administrating your sales ledger. For invoice factoring, this charge is sometimes called the credit management fee.
This fee varies depending on the size of your turnover. For invoice factoring, companies can typically expect to pay between 0.75% and 2.5% of their annual turnover for their factoring facility. Usually, the service fee is cheaper for an invoice discounting facility, often starting at as low as 0.25%. If your annual turnover shrinks or grows, your invoice provider will adjust your service fee accordingly.
Discount fee
The discount fee is the borrowing charge, calculated as a percentage of the invoice value. It’s the amount you pay in return for a lender releasing the advance to you, working in the same way as bank interest. For a factoring facility, this amount is usually 0.5%-5% of the total amount of the invoice. Again, the discount fee will be less for an invoice discounting facility, often not exceeding 3%. As a general rule, the higher the value of the invoice for which you want to receive an advance, the lower the discount charge will be.
Additional fees
Some companies include extra charges for certain services or offer add-ons for an additional cost. A lot of finance providers charge a fee for setting up the facility. Some charge an additional administration fee to audit your financial documents and many include a minimum usage fee which you’ll have to pay if you don’t process a certain amount of invoices per month. For a contracted factoring facility, there may also be an early termination fee if you wish to leave your contract before it elapses.
Before you sign an agreement, be sure to look at all the charges involved and ask for clarification on any points which aren’t explicitly clear, to avoid any costly surprises later on.
Final thoughts and FAQ’s
Invoice finance (invoice discounting and invoice factoring), is becoming a popular way for companies to get their operating liquidity flowing, vital for smooth-running daily operations and business growth.
As we’ve seen, invoice finance bases itself on money that’s soon to come in. As companies use their accounts receivable ledger as collateral, they are safe in the knowledge that the borrowed funds are almost guaranteed to come in within a matter of weeks or months. This security makes it an appealing form of borrowing for both the borrower and lender, reducing the risk for both parties as opposed to traditional finance (i.e. business loans, commercial overdrafts…).
Whether you opt for invoice factoring or invoice discounting will depend on factors such as the budget you have available, the size of your business and, principally, how much control your business needs over its sales ledger.
Whichever invoice-backed finance solution works best for you, both factoring and discounting can help to relieve the financial burden of extended payment terms and liberate cash tied up in invoices.
What Are Recourse and Non-recourse Agreements?
When you acquire an invoice finance facility, your agreement will either be with recourse or without recourse. This differentiation determines who assumes liability for the debt, should a customer refuse to pay or default on their payment. An agreement with recourse means that you will still have to pay the lender, even if the customer payment doesn’t come through.
In practice for non-recourse agreements, the lender provides Bad Debt Protection, which safeguards your business against damage from an unpaid or delayed bill, almost like an insurance for your business. In other words, the lender assumes the credit risk, protecting your company from the threat of insolvency.
While a non-recourse agreement reduces the company’s risk, this reduced risk comes at a price. Non-recourse contracts are typically more expensive than agreements with recourse. In some cases, the portion of advanced cash will represent a smaller percentage of the invoice value. For companies with several high-paying clients, or any unreliable customers, the higher fees associated with a non-recourse agreement may be worth considering against the potential damage from a defaulting customer.
Finally, make sure you check the small print when it comes to a non-recourse agreement. Even in a contract without recourse, many invoice finance companies reject liability in certain situations. This is the case for some invoice disputes. Make sure that these terms are explicit, as you don’t want to pay a higher rate and take the hit from customer debt.
Is Invoice Finance Regulated?
Asset-based finance and thus invoice finance is not regulated in the UK, which means providers have free reign when it comes to negotiating their fees, contracts and products. They aren’t accountable to any industry bodies (unless registered with the ABFA), which means they’re under no obligation to adhere to any industry-wide standards or protocol. For this reason, it’s advisable to take time choosing a finance provider and you should always seek professional advice.
