Invoice financing guide
But just what is invoice financing? And can it help your business?
Let’s find out…
What is invoice financing?
Invoice financing involves a third party, such as a bank, buying your unpaid invoices off you or lending you money against the value of those invoices.
There are two main types: factoring, and invoice discounting.
Factoring (or debt factoring), is when the bank (the invoice financier) actually collects money owed by your customers – meaning they will know you are using this type of funding.
Invoice discounting is when the invoice financier lends you money against your unpaid invoices, but you continue to collect money from your customers. This money then goes towards paying off your loan. This is most suited to established companies with annual turnovers of at least £250,000.
How can it help a business?
In essence, invoice financing allows you to access funds you are due without waiting for your clients or customers to pay up.
In the short term, it can be a great way out of a cashflow crisis.
And in the longer term, it can be a useful tool to ensure things keep ticking along nicely even when clients fail to pay on time.
How does it work?
How invoice finance works depends on the type of agreement you enter into:
With factoring, the invoice financier buys the debt owed to you by your customer, making a percentage of that amount – usually about 85% – available to you upfront. It then collects the debt directly from the customer and gives you the remaining balance once the money is in its account – all in return for a fee and interest charges.
*With invoice discounting, the financier loans you the money owed and you repay this loan as your customers pay their invoices. You remain responsible for collecting the invoice payments, meaning you can keep the finance agreement a secret from your customers. Once again, there are interest charges and a monthly fee for the service.
What are the advantages?
The main advantage of both types of invoice financing is that you receive an immediate cash injection.
Advantages of factoring include:
- You no longer need to worry about chasing payments, leaving you free to manage your business
- The invoice financier will credit-check potential customers, making it easier to weed out late or non-payers
- In some cases, the financier will also be able to negotiate better terms with your debtors
Other advantages of invoice discounting include:
- There is no need for your clients or customers to know you are borrowing against their invoices
What are the disadvantages?
Clearly, there is a cost associated with invoice financing, and that means you won’t receive the full income you could from the services you provide.
You may also find it harder to get funding from other sources due to using invoice financing, which is not generally available to businesses that sell to the public.
Other disadvantages of factoring include:
- You lose control of the relationship with your clients, which could affect their opinion of your business
- You may find it hard to get out of invoice financing once you have begun as you begin to rely on the steady cash flow
Other disadvantages of invoice discounting include:
- Providers will only lend against invoices due from clients or customers they expect to pay up
- You will need to satisfy the provider that you can manage your own invoice administration.