Invoice finance is a term based on different types of asset-based financing. Businesses sell their invoices to a third party finance company for a percentage of the value of the invoice(s).

This can be useful for a business that suffers from low cash flow due to the money locked in the invoice. The third-party finance company will pay a percentage of the value for the business to be able to use the money and repay the loan when the invoice gets settled.

A form of invoice finance has been available in the UK for centuries, as early as 1400 and has been part of the early merchant activities.

How Does Invoice Finance Work

Here are five steps to show how invoice finance works. Let’s say company X needs immediate finance.

Below are the steps a company would take.

  1. Company X has an invoice or several invoices that are due to be paid soon. But cannot wait and require cash flow immediately.
  2. Company X approaches an invoice finance company to get some cash flow from the invoice(s).
  3. The finance company offers Company X a percentage of the amount on the invoice, plus fees.
  4. Company X accepts the offering, and the money is released to the company X within 48 hours.
  5. Company X gets the money owed for their invoices and repays the finance company plus any additional fees.

Why Would a Company use Invoice Financing

Unlike many other forms of finance, which require trading history, established records and good credit history, invoice finance is an alternative form of funding to raise cashflow.

The money can be raised quickly against the invoices; in some cases, money can be in the businesses accounts within 48 hours.

Types of Invoice Finance

There are two main types of invoice finance, and each one works in a specific way. Click on the names to find out how they work.

The first is Invoice Factoring

The second is Invoice Discounting

Single Invoice vs Multiple Invoices

A business can finance their whole ledger, or they can raise finance for a single invoice.

This is typically known as spot factoring; spot factoring is a selective or single discount invoicing. 

Spot factoring is ideal when a company has a large value and a few single invoices. Late payment on the invoice may put a company in some difficulty, and this is where factoring comes in very useful.

Regulated or Unregulated

The Financial Conduct Authority (FCA) does not regulate invoice finance in the UK. It means there is no real protection for this type of finance. 

It is highly recommended to conduct your due diligence on any lender you may want to do business with and their charges.

Some things to look out for:

  • Make sure any contract does not exceed twelve months.
  • All charges are transparent, and there are no hidden fees.
  • A clear termination structure.
  • Fair termination fee.

Costs Involved

Invoice financing is an unregulated form of finance in the United Kingdom. Before applying for this form of finance, it is useful to understand the costs that are involved.

Let us break down some costings for finance for factoring and discount invoice finance.

Service Charge

The service charge includes management, collections and administration costs; the typical rates are between 0.75% and 2.5% of the gross business turnover.

Discount Charge

The discount charge works on an interest rate levied against the drawdown amount. The cost will be between 1% to 3% above the base rate; the charges are calculated daily, putting you at risk of higher repayments if the customer delays in paying your invoice.

The interest is paid either every week or monthly, subject to the lender’s terms.

What is the Eligibility Criteria

To apply for invoice finance there are specific eligibility criteria you must meet. The following outlines some of the requirements:

  • You must be a registered company either Limited (Ltd) or LLP
  • You are a business to business company. 
  • Your business offers industry-standard credit terms.
  • Your business turnover exceeds £50K per annum.
  • Some lenders may have a minimum invoice sent per month criteria.
  • You are trading for a minimum of 3 years.

There may be other requirements for some lenders. It is worth checking different lenders to see if you meet the minimum standards.

Advantages of Invoice Finance Compared to a Business Loan

There are some obvious advantages for a business to use invoice finance rather than a standard business loan. Let’s break down a few of the benefits.

  • The access to finance is much faster with invoice financing.
  • They are more flexible compared to a business loan or overdraft.
  • The funding line can grow as you grow.
  • You get a greater level of finance on assets.
  • Reducing the risk to the company on late payments or default clients.

Invoice Finance Protection

Bad debt protection is something that can be added to the invoice finance. It is a type of insurance that offers protection should the client fail in repaying the invoice.

It is worth noting that adding this to the finance will make the finance more expensive. It is useful for businesses in a high-risk sector as part of the overall management. 

Protection can be as much as 90% of the finance amount and responsibility is to the factor assuming there is a default on the invoice.