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7. Invoice financing

Invoice financing is where a third party agrees to buy your unpaid invoices for a fee. Invoice financiers can be independent, or part of a bank or financial institution.

There are 2 types of invoice financing in the UK.

Factoring

‘Factoring’ – also known as ‘debt factoring’ – usually involves an invoice financier managing your sales ledger and collecting money owed by your customers themselves. This means your customers will know you’re using invoice finance.

  1. When you raise an invoice, the invoice financier will buy the debt owed to you by your customer.
  2. They make a percentage of the cost (usually around 85%) available to you upfront.
  3. They then collect the full amount directly from your customer.
  4. Once they’ve received the money from your customer, they make the remaining balance available to you.
  5. You’ll have to pay them a discount charge (interest) and fees – the amount depends on which invoice financier you use.

Example
You’re owed £40,000 by a customer. You sell the invoice to an invoice financier for £34,000 (85%). They collect £40,000 from your customer and pay you the remaining £6,000 when they receive the money. You pay them interest and any fees you owe.

Invoice discounting

With ‘invoice discounting’, the invoice financier won’t manage your sales ledger or collect debts on your behalf. Instead, they lend you money against your unpaid invoices – this is usually an agreed percentage of their total value. You’ll have to pay them a fee.

As your customers pay their invoices, the money goes to the invoice financier. This reduces the amount you owe, which means you can then borrow more money on invoices from new sales up to the percentage you originally agreed.

You’ll still be responsible for collecting debts if you use invoice discounting, but it can be arranged confidentially so your customers won’t find out.

Advantages

Both kinds of invoice financing can provide a large and quick boost to your cash flow.

Advantages of factoring include:

  • the invoice financier will look after your sales ledger, freeing up your time to manage your business
  • they credit check potential customers meaning you are likely to trade with customers that pay on time
  • they can help you to negotiate better terms with your suppliers

Advantages of invoice discounting include:

  • it can be arranged confidentially, so your customers won’t know that you’re borrowing against their invoices
  • it lets you maintain closer relationships with your customers, because you’re still managing their accounts

Disadvantages

Some disadvantages of invoice financing are that:

  • you’ll lose profit from orders or services that you provide
  • invoice financiers will usually only buy commercial invoices – if you sell to the public you might not be eligible
  • it may affect your ability to get other funding, as you won’t have ‘book debts’ available as security

If you use factoring:

  • your customers may prefer to deal with you directly
  • it may affect what your customers think of you if the invoice financier deals with them badly

Find funding

You can look for either: