Invoice Finance – what is it and how can it help my business?

Invoice finance is an umbrella term for two distinct forms of business funding called invoice discounting and invoice factoring.

It’s likely you’ll have heard of these alternative types of business finance before, but without knowing exactly how they work, you might dismiss them as just another financial product that you and your business don’t need. However, there are real benefits to these products, so here is what every business owner should know about invoice finance.

What is invoice finance?

Very simply, invoice finance allows you to unlock the value of your unpaid invoices so you can close the gap between the invoice date and the payment due date – for a fee of course.

Here’s how the process works:

  • Your first job is to agree a deal with an invoice finance provider;
  • You then issue an invoice to a customer as usual;
  • And send a copy of the invoice to the finance provider;
  • They then pay you an advance of up to 95 percent of the value of the invoice within 24 hours;
  • The customer pays the invoice when the payment is due;
  • You receive the balance of the invoice minus the invoice finance provider’s fee.

Importantly, the advance payment is secured against the unpaid client invoice. That means, unlike a secured loan, no company assets other than the invoice is used as collateral.

Invoice discounting and invoice factoring – what’s the difference?

There are important differences between invoice discounting and invoice factoring which make them more suited to particular business types.

Invoice discounting

Invoice discounting is the simpler of the two products and is better suited to larger companies that already have an in-house credit control operation in place.

That’s because the business maintains the responsibility for all aspects of the invoicing process and for chasing payment. That ensures the confidentiality of the arrangement and allows you to retain control of your sales ledger.

Whole invoice discounting and selective invoice discounting facilities are available.

Whole invoice discounting allows businesses to raise finance against their entire sales ledger.

Selective invoice discounting lets businesses pick and choose which invoices they raise finance against.

Invoice factoring

This is generally a more popular option for smaller businesses because it includes additional elements, such as an outsourced credit control and collections process.

Effectively, the business sells its ownership of its sales ledger. The invoice factoring provider is responsible for credit checking prospective customers and chasing payments.

This can free up the business to concentrate on its core activities. However, the facility will be disclosed, so the customer will be aware you are working with a finance provider.

Spot factoring is a facility offered by some finance providers. This allows businesses to choose the invoices they raise finance against. However, in most cases, invoice factoring is a whole turnover facility.

What are the benefits of invoice finance?

Both of these finance types have a compelling range of benefits for firms of different sizes:

  • It releases the cash-flow tied up in invoices so businesses can pay bills and suppliers, purchase stock and take advantage of opportunities to grow;
  • It reduces the impact of late payments;
  • Funding can be secured without requiring other assets;
  • The level of funding available increases in line with turnover;
  • Significantly more cash can be raised than with a bank loan or overdraft facility;
  • Freeing up the cash to pay supplier invoices quickly allows businesses to take advantage of early payment discounts;
  • Invoice factoring, in particular, is an effective way for start-ups to access funds when they might not be able to do so through other means.
  • Invoice factoring gives small businesses access to an outsourced credit control team so these are processes they don’t need to invest time or money in;
  • Even in large firms, invoice finance can be useful as a low-rate form of borrowing, with fees agreed upfront and no accumulation of interest.

And the disadvantages..?

There are drawbacks to every type of business funding and invoice finance is no different:

  • Profit margins will fall as a percentage of every sale is paid to the finance provider;
  • Some customers may perceive invoice finance negatively and assume the business struggling. That’s why the confidentiality provided by invoice discounting makes it a popular option;
  • The majority of finance providers only allow companies to borrow against commercial invoices so businesses selling to the general public may not be eligible.
  • Businesses can rely on this type of facility too heavily rather than working to bargain with debtors to ensure prompt payments.

This guide has been written exclusively for ByteStart by Business Expert, who have built the UK’s first dedicated invoice finance comparison engine.

Last updated: 13th April, 2021

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