Key points
- A provider advances most of each invoice's value and pays the balance less fees when the customer settles.
- Factoring means the provider collects from your customers. Invoice discounting means you collect, often without customers knowing.
- Facilities can cover the whole sales ledger or selected invoices only.
- Costs are a service fee on turnover plus a discount charge on the money advanced.
- It suits businesses selling to other businesses on credit terms. It does not suit cash sales or consumer trade.
What is invoice finance?
Invoice finance releases cash against unpaid business-to-business invoices before customers pay. Instead of waiting 30, 60 or 90 days for a customer to settle, the business raises the invoice, sends a copy to the finance provider and receives most of the value within a day or two. The provider is repaid when the customer pays. The facility is secured on the invoices themselves, so the business needs no property to borrow against.
Factoring and invoice discounting
The two main forms differ in who chases the money and whether customers know.
- Invoice factoring. The provider takes over credit control. It sends statements, chases payment and receives the funds directly. Customers are told that invoices have been assigned. Factoring suits smaller businesses without a credit control function and usually costs more because the provider does more work.
- Invoice discounting. The business keeps control of its sales ledger and collects payment as normal, paying receipts into a trust account that the provider controls. Most invoice discounting is confidential, meaning customers are unaware. Providers require a stronger business with reliable systems.
Disclosed invoice discounting also exists, where customers are notified but the business still collects.
Whole-ledger or selective facilities
A whole-ledger facility covers every eligible invoice the business raises. It provides the steadiest funding line but commits the business to a contract, often twelve months or more, with minimum fees. A selective or spot facility lets the business choose which invoices, or which customers, to finance, paying only for what it uses. Selective finance is more flexible and suits occasional large invoices, but the fee per invoice is higher.
How an advance works
- Raise the invoice to the customer as normal, with payment terms of, say, 60 days.
- Upload it to the provider, who checks that the goods or services have been delivered and the invoice is undisputed.
- Receive the advance, typically between 70 and 90 per cent of the invoice value, within 24 to 48 hours.
- The customer pays the invoice in full, either to the provider under factoring or into the trust account under discounting.
- Receive the balance, the remaining 10 to 30 per cent, less the provider's fees.
The advance rate depends on the quality of the customers and the spread of the ledger.
What does invoice finance cost?
There are two main charges. The service fee is a percentage of the gross invoice value, covering administration and, for factoring, credit control. The discount charge is interest on the money advanced for the days it is outstanding, usually expressed as a margin over the Bank of England base rate.
Beyond those, look for arrangement fees, audit fees, minimum monthly fees, re-factoring fees on invoices past a set age, and termination fees for leaving early. The total can be reasonable for large, promptly paid invoices and expensive for many small, slow ones. Ask for a worked example based on your own ledger.
An illustrative example
A business raises a £10,000 invoice on 60-day terms. The provider advances 85 per cent, or £8,500, the next day. The customer pays on day 60. The provider releases the remaining £1,500 less a service fee of, say, 1.5 per cent (£150) and a discount charge for 60 days on £8,500 at an illustrative annual rate of 8 per cent (around £112). The business receives £1,238 and has paid about £262 for having £8,500 two months early. These figures are illustrative only and are not an offer or quote.
Recourse, non-recourse and bad debt protection
Under a recourse facility, if a customer does not pay, the business must repay the advance. The credit risk stays with the business. A non-recourse facility includes bad debt protection, under which the provider absorbs the loss if an approved customer becomes insolvent. It costs more and usually covers only approved customers up to a stated limit, and only insolvency rather than disputes. For a business dependent on a few large customers, that protection can be worth the premium.
Who does invoice finance suit?
The best fit is a business that sells to other businesses on credit terms, issues invoices for completed work, has a spread of creditworthy customers and is growing faster than its cash allows. Recruitment agencies, wholesalers, manufacturers, haulage firms and professional services firms are typical users. Long debtor days make the case stronger. Our manufacturing and transport and logistics pages discuss the sector angle.
Who does it not suit?
Businesses selling to consumers cannot use it, because the invoices are not to businesses. Cash sales and card sales produce no invoice to finance. Invoices raised in advance or dependent on milestone sign-off are hard to fund because they are not yet unconditional debts. Construction is the clearest example: applications for payment, retentions and stage payments under contract need specialist construction finance rather than a standard facility. See our construction page.
Replacing an overdraft or easing cash flow pressure
Many businesses move to invoice finance when a bank reduces or withdraws an overdraft. Unlike an overdraft, the facility grows as sales grow and is tied to specific invoices rather than to the bank's appetite. For a business under cash flow pressure because customers pay slowly, it addresses the cause directly. It does not help where the problem is thin margins or a lack of sales.
Benefits and drawbacks
Potential benefits
- Funding rises in line with sales
- No property security is needed
- Cash arrives within days of invoicing
- Factoring removes the burden of credit control
- Bad debt protection is available at extra cost
Possible drawbacks
- Fees can add up on small or slow-paying invoices
- Contracts often have minimum terms and exit fees
- Customers may learn of the arrangement under factoring
- Concentration limits restrict funding against one large customer
- The provider takes a debenture over the whole debtor book
Risks to understand
Concentration limits mean a provider may fund only a set share of the ledger from any one customer, which can leave a business with one dominant client underfunded. Dependence is a second risk: once the advance is spent, leaving the facility means finding that cash again. The debenture over the book ranks ahead of other creditors, which limits other borrowing and complicates a later restructuring. Under factoring, heavy-handed collection can damage customer relationships, so ask how collections are handled.
Alternatives to consider
- Working capital finance where the gap is caused by stock rather than debtors.
- Asset-based lending for larger businesses that want receivables, stock and plant funded together.
- An unsecured business loan for a one-off requirement rather than a continuing facility.
- Tighter credit control, deposits and prompt-payment incentives, covered in how to improve business cash flow.
- Free, impartial advice from Business Debtline if the business is already behind with its creditors.
Frequently asked questions
How quickly can an invoice finance facility be set up?
Selective facilities can be live within a few days. Whole-ledger facilities usually take two to four weeks, including an audit of the sales ledger and credit checks on major customers.
Will my customers know I am using invoice finance?
Under factoring, yes, because the provider collects payment. Under confidential invoice discounting, no, provided the business maintains the trust account and procedures correctly.
Can a new business use invoice finance?
Often, because the provider is relying on the creditworthiness of the customers rather than the trading history of the business. Factoring is more likely than confidential discounting for a start-up.
What happens if a customer disputes an invoice?
Disputed invoices are generally excluded from funding and any advance already made must be repaid. Bad debt protection covers insolvency, not disputes.
Does Finance Business Debt provide invoice finance?
No. We explain how the products work and, where appropriate and at your request, may introduce you to third-party finance providers. See our regulatory information.