Invoice finance describes a range of invoice-based lending facilities, that allow your business to sell your invoices to a third party in exchange for a percentage of their value, thus preventing the adverse effects that slow and late payments can have on your cash flow. In this guide, we explain what invoice finance is, how it works, and what different types of agreements may be available to you.
What is invoice finance?
Invoice finance is a form of borrowing based on what your clients and customers owe to you in the form of unpaid invoices. As customers may have up to 90 days or more to pay their debts to your business, this type of financing allows you to unlock cash from these invoices. In simple terms, you ‘sell’ your unpaid invoice at a discount, receiving the remaining balance after payment.
With invoice finance, some of these funds become available as soon as invoices are raised, solving short-term cash flow concerns. You can use the funds raised from invoice financing for a variety of purposes, from paying employees and suppliers to funding business growth initiatives. In this way, it can be seen as an alternative method of business funding compared to more traditional business loans and overdrafts.
How does invoice financing work?
The way invoice finance works depends on the type of agreement, but in general, it will involve the following process:
- You invoice your clients and customers as normal and pass the invoice details to your invoice finance provider
- Your provider pays you a percentage of the invoice
- Depending on the agreement, you will either chase the payment as normal (if necessary) or your provider fulfills this credit control function
- Once the invoice is paid, you will receive the remainder of the invoice amount, minus any service charges
There are numerous benefits of invoice finance. Firstly, there are few restrictions in terms of sector and business size, meaning that it can be used for short term cash flow needs all the way through to funding substantial growth projects. Secondly, an invoice finance facility can be set up relatively quickly, meaning that it provides quick funding. Finally, it can act as a safety net, allowing you to manage your cash flow much more easily and efficiently.
Types of invoice finance
Invoice finance is a collective term for a number of different invoice-based funding solutions.
The key difference between these types of finance is around credit control, and who is responsible for chasing late payments.
Invoice factoring
With invoice factoring, the finance provider takes control of managing your credit control and debt collection processes. This means they will contact your customers to collect payments, leaving you to focus on running your business. While factoring can be very beneficial for businesses with limited internal resources for managing collections, your customers will be aware that you are using invoice finance.
Invoice discounting
In contrast, with invoice discounting, you retain full responsibility for chasing late payments. This means your customers are unaware that you are using an invoice finance facility, offering greater confidentiality. However, invoice discounting typically requires a more established business with higher turnover and robust internal credit control systems.
Selective invoice finance
Selective invoice finance allows businesses to choose specific invoices or customer accounts to finance, rather than committing all invoices to a finance facility. This offers greater flexibility for businesses that only need a temporary cash injection. It’s ideal for businesses that don’t want to rely on invoice finance for their entire ledger but still want to take advantage of the facility on a case-by-case basis.
Who is eligible for invoice finance?
Invoice finance is not available to every business. To qualify, certain criteria must be met to ensure both the lender and the business are set up for success. The main factors influencing eligibility include:
- Business type: Invoice finance is generally more suitable for B2B (business-to-business) companies. Since invoice finance relies on customers owing money to the business, it works best when your customers are other businesses rather than individual consumers. However, some B2C businesses may be eligible, depending on the nature of their transactions.
- Trading history: Lenders typically prefer businesses that have been trading for a certain period, usually at least 6 months to 1 year. A strong history of issuing invoices and receiving payments will make you a more attractive candidate for invoice finance. Startups or businesses without a clear track record may find it more difficult to secure funding.
- Amount to borrow: While there’s no strict minimum for invoice finance, if you need to borrow large sums (over £1 million), you may be better suited to other types of business financing, such as asset-based lending or a business loan. Invoice finance is generally more suitable for businesses with smaller to medium-sized financing needs.
- Customer payment habits: Lenders will review your customers’ payment history to assess the likelihood of timely payments. If your customers have a history of paying late or have poor credit, it may reduce your chances of approval or affect the terms offered.
By ensuring that your business meets these criteria, you’ll be more likely to receive favourable terms from lenders and have a smoother application process.
Are there any risks associated with invoice finance?
We have covered some of the advantages of invoice finance, primarily having access to a large proportion of an invoice within a matter of days and not having to take on extra liabilities or debt. However, there are some key things to consider when choosing an invoice finance solution.
Firstly, you may be concerned with potential damage to customer relationships if a third party manages credit control on your behalf. In this case, discounting would be preferable to factoring.
Secondly, you may have a legitimate concern with customers becoming insolvent and therefore being unable to pay their invoices. While ensuring that credit checks are made beforehand helps lower the risk of this kind of bad debt, it can also be mitigated by taking out bad debt protection as part of your invoice finance agreement. This works as a form of insurance that means that you’ll get paid even if customers become insolvent.
Finally, you may not want to put your entire ledger through the invoice finance facility, instead preferring to just finance a small number of invoices. In this case, single invoice finance would be a good option, particularly if you’re looking for a one-off cash injection.
White Oak UK offers SMEs the full range of business funding products, including asset finance, asset-based lending, invoice finance, and business loans.
We’ve cut the red tape from our business to offer quick, simple, and straightforward finance solutions so you can work more efficiently and effectively.
Talk to one of the team today on 0372 291 2766 and discuss your invoice finance options today.
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