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Invoice Financing: Can it help your business?

Release the cash tied up in your invoices through our partner Think Business Loans

Tim Heming
Written by  Tim Heming
Jonathan Leggett
Reviewed by  Jonathan Leggett
5 min read
Updated: 27 Nov 2023

Our guide explains how invoice financing works and how it could be the right funding option for small businesses

What is invoice financing?

Invoice financing is a form of lending based solely on outstanding invoices. It involves a third party, often a bank, buying up your unpaid invoices or lending you money against the value of the accounts receivable.

So as your business continues to provide services or goods to your customers, you in turn hand these invoices to a provider who pays your business a percentage. Once the invoice is paid and the service charge of the provider is covered, you’ll receive the remainder of the sum.

As money is often tied up in invoices during the day-to-day running of a business, this form of financing can potentially speed up cashflow. The higher the value of your invoices, the more you can potentially borrow through this type of financing.

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Types of invoice financing

There are two main types of invoice financing:

  • Factoring, also known as debt factoring, is when the invoice financier collects the money owed by your customers. This means you are not taking out a loan but selling an asset worth revenue. It is usually large-scale companies that opt for factoring

  • 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. Invoice discounting is most suited to established companies with an annual turnover of at least £250,00

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 the amount – usually about 85% – available to you up front.

The financier then collects the debt directly from the customer and pays you the remaining balance once the money is in the account – all in return for a fee and interest charges.

When it comes to 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, while interest charges, as well as a monthly fee for the service, still apply.

What’s the difference between a business loan and invoice finance?

Business loans and invoice financing cater to different financial needs of businesses. 

A business loan provides a lump sum amount that the borrower must repay to the lender over a specified period with interest. This form of financing is suitable for various purposes such as expansion, equipment purchase, or working capital.

In contrast, invoice financing accelerates cash flow as a percentage of each invoice is paid more quickly. Unlike a traditional bank loan, invoice financing relies on the creditworthiness of a business's customers rather than the business itself.

Choosing between a business loan and invoice financing depends on the specific financial needs of the business. Business loans are suitable for larger, one-time expenses or strategic initiatives. In contrast, invoice financing is beneficial for businesses with outstanding invoices, providing quick access to working capital without taking on additional debt. 

What are the advantages of invoice financing?

  • Invoice financing allows you to access funds you are due without waiting for your clients or customers to pay the amount owed, and therefore saves your business valuable time and speeds up cashflow

  • In the longer term, invoice financing can be a useful tool to ensure a business runs smoothly even when clients fail to pay on time. Providers will often take charge of chasing expected payments and providing credit checks for potential customers

  • Invoice financing makes for a flexible option as you can increase the fund request as your revenue grows, as well as scale it back when you need to

What are the disadvantages of invoice financing?

  • There is a cost associated with invoice financing, which means you won’t receive the full income from the services you provide, as the third-party takes a cut including a monthly interest rate and service fees

  • You may also find it harder to get funding from other sources when using invoice financing, which is not generally available to businesses that sell to the public

  • Providers will only lend against invoices due from clients or customers they expect to pay

  • You will need to satisfy the provider that you can manage your own invoice administration

Is invoice financing viable for small businesses?

Invoice financing can be a viable and beneficial practice for small businesses because it offers a practical solution to cashflow challenges. 

For small businesses facing delayed payments from clients, invoice financing ensures a timely influx of working capital, enabling them to meet operational expenses, invest in growth, and seize business opportunities. 

Additionally, invoice financing doesn't increase debt as it involves selling invoices to a lender, making it an attractive option for businesses with limited borrowing capacity. 

However, the decision to use invoice financing should consider the associated costs, such as fees, interest rates and discount rates, as well as the potential impact on customer relationships if you use invoice factoring and your lender takes charge of collecting invoice payment. 

Compare business invoice financing providers on MoneySuperMarket

If you’re looking to accelerate cashflow in your business invoice financing through MoneySuperMarket’s partner Funding Xchange could offer the solution. 

You just answer a few brief questions about the type of business you run and what you’re looking for and you’ll receive a tailored list of great options for you to consider. 

It is easy to browse and compare and you’ll be provided with all the information you need to make an informed decision. 

Compare invoice finance