Invoice finance could give your business a quick cash injection by enabling you to get paid faster. Invoice finance is a form of secured business lending that allows you to borrow money using your unpaid invoices as collateral. Instead of waiting for your customers to pay for the service you provide, you’ll get most of the cash right away.
If your business relies heavily on invoices and your cash flow is subject to fluctuations as a result, then invoice financing can offer much-needed financial breathing space. But in return, you’ll have to pay interest and/or fees to the company that provides the service.
Invoice discounting vs factoring
There are 2 commonly available types of invoice finance:
Invoice factoring. The finance company effectively buys your unpaid invoices and is in charge of collecting the debt from your customers.
Invoice discounting. The finance company lends you money against your invoices, but they still belong to you. You’re still in charge of dealing with your customers.
Invoice finance is quite expensive, but it can also be easier to obtain than, say, an unsecured business loan. Since your invoices act as collateral, the lender can afford to take some extra risk with your business and may be able to lend you money even if you haven’t been trading for a long time or your business credit score isn’t great.
Invoice factoring: how does it work?
If you set up invoice factoring (also sometimes called “debt factoring”), you’ll sell some or all of your customers’ unpaid invoices to a finance company.
The company will pay you the majority of the invoices’ value right away – usually up to 85-90% of it within 48 hours – and the rest when the customers pay it, minus the agreed charges.
If you sell all your invoices to the finance company, you won’t need a credit department because the company will do the dirty job of harassing your clients to get the money they owe you. However, this comes at a price, so invoice factoring is usually more expensive than invoice discounting.
Pros and cons of invoice factoring
Pros
You outsource credit collection
Better cash flow for your business
Can be available even with bad credit
Your credit limit effectively grows as your company grows – the greater the volume of invoices you raise, the more you can borrow
If a customer won’t pay, you won’t be obligated to repay the money yourself
Cons
More expensive
Your clients will know you’re using a factoring provider, as you won’t be the one collecting payments, and it may damage the image of your company
Your clients may prefer dealing with you directly
Not much flexibility, as often you have to pre-arrange how many of your invoices the company will buy and for how long
You may be asked to finance all your invoices
Need more flexibility? Consider invoice trading
Invoice trading is a flexible version of invoice factoring. Instead of selling your invoices to a finance company, you use a dedicated platform to sell them to single individuals or groups of individuals.
You can decide which invoices you want to sell and opt out at will.
You’re still outsourcing credit collection, but only for a limited number of invoices.
Invoice discounting: How does it work?
In terms of cash flow, the basics are the same: you get up to 85-90% of your invoices’ value immediately in exchange for a fee. However, the finance company is effectively lending you the money against your unpaid invoices rather than buying them outright.
Your invoices remain yours, and so do the credit and the responsibility that comes with it. This means you will still need an effective credit department to chase the invoices as necessary. Once you’ve received payment from your customers, you will need to repay the loan plus an agreed fee to cover costs, risk and interest. If the customer doesn’t pay you back within the established period, the finance company may take its money back.
As you’re still the one dealing with the customers, they won’t need to know you’re using invoice discounting, and the cost will usually be lower.
Pros and cons of invoice discounting
Pros
You retain control over credit collection
Your customers don’t necessarily need to know
Better cash flow for your business
Can be available even with bad credit
Like invoice factoring, the more money your business makes, the more you can borrow
Cons
You’ll be directly responsible for credit collection
There may be extra fees if a customer is late
If a customer doesn’t pay, you still need to repay the loan
You may be asked to finance all your invoices
How to compare invoice finance providers
Depending on the financial needs of your business, here are some of the things you may want to check before picking your invoice finance provider:
Factoring/discounting fee. How much of the invoice value will the financial company retain?
Opening fee. There’s usually an initial charge to set up the service.
Immediate cash. When you send out an invoice, you’ll get a percentage of its value immediately and the rest when the customer pays. Make sure you check how much you get immediately – the more it is, the better value you are getting from your fee.
Length of commitment. Some providers require a 12-month or 24-month minimum commitment, while others offer shorter term options.
Number of invoices involved. Does the provider ask you to finance all your invoices or only some of them? How many?
Bad debt protection. What happens if one of your customers doesn’t pay you back? Are you protected, or is there an extra fee to pay?
What is selective invoice finance?
Selective invoice finance is a flexible type of invoice finance that allows you to pick which invoices you want to finance. It’s also possible to get more money from the beginning – you can sometimes get up to 100% of the invoice value upfront. It isn’t offered by all providers, but it’s becoming more common.
What is the difference between invoice factoring, invoice discounting and selective invoice finance?
The key differences between invoice factoring, invoice discounting and selective invoice finance are outlined in the table below:
Invoice factoring
Invoice discounting
Selective invoice finance
Finance provider purchases invoices from you outright.
Finance provider lends you a percentage of the invoices’ value.
You can pick and choose which invoices you want to finance rather than your entire ledger.
Company collects invoices from customers on your behalf.
You, as a business, must collect invoices from customers.
Company can collect invoices on your behalf or you might be able to, depending on the provider.
You’ll get an immediate advance, usually up to 90% of the invoices’ value. The remaining balance is paid to you once the invoices have been paid, minus any fees.
Finance company lends you a percentage of your outstanding invoices (usually up to 90%), and you repay this money, plus an agreed fee.
You’ll get an immediate advance, which could be up to 100% of the invoices’ value.
Customer is aware you’re using a factoring provider.
Customer won’t be aware you’re using a finance provider.
Whether the customer knows depends on the provider you choose.
Can be easier for smaller or early-stage companies to get accepted.
Better for more established businesses with higher turnover.
Available to early-stage businesses.
Is invoice finance right for my company?
Invoice finance is generally good for businesses that have a fluctuating cash flow. For example, a company may have a few big customers that are powerful enough to demand long credit terms or the company’s line of work has high initial costs (that can be due to the need to buy expensive raw materials, for instance).
Invoice finance can also be a good choice if your company is growing quickly because the amount of money you get is flexible and ultimately depends on your turnover.
On the other hand, invoice finance companies usually only offer business-to-business services, so if most of your turnover (and your financial issues) comes from the public, it probably isn’t what you’re looking for.
Moreover, don’t forget that if you have a good credit score or own assets that allow you to secure the loan, a regular business loan may be a cheaper option.
Alternatives to invoice finance
Invoice finance tends to be expensive, so make sure you’ve exhausted all the alternatives before going for it.
Apply for a credit card or overdraft. If your credit score is good enough, a business credit card or overdraft may offer a cheaper alternative to invoice financing.
Apply for a business line of credit. An ongoing business line of credit puts an emphasis on flexibility. You only borrow what you need, when you need it and for as long as you need it (subject to agreed limits).
Apply for a business loan. There are multiple types of business loans, one of which may be available to you at a cheaper cost. Check Finder’s guide on business loans to learn more.
Raise money from investors. A crowdfunding campaign may also be worth a shot.
Eligibility criteria tend to change from provider to provider, so don’t forget to check them before applying. You don’t want to waste your time with an application if your business doesn’t meet the criteria.
As a rule of thumb, invoice discounting requires a higher turnover than invoice factoring. Invoice discounting is more likely to require you to have been trading for a set amount of time, too.
Finally, if your business exports products and your invoices are paid by clients overseas, some lenders may add extra conditions or be unable to help.
Bottom line
Invoice finance can be a great way for businesses to boost cash flow, help meet their financial obligations, and take advantage of growth opportunities. But you’ll need to consider which type of invoice finance best matches your business needs and also compare it to other finance options to see what works out to be the most cost-effective solution for you and your company.
Frequently asked questions
Invoice finance can be a good idea if you need to boost your cash flow, but you want to offer your customers longer payment terms. In this situation, it can be a useful way to help your business become more profitable. But it won’t be right for every business.
Not necessarily since invoice discounting is usually done confidentially. However, with invoice factoring, confidentiality will be impossible because the finance company chases payments for you.
It’s possible. You’ll have less collateral available, which may impact your chances to obtain funding through other channels.
To qualify for invoice finance, you will need to prove you issue invoices for customers. Some providers ask for a minimum annual turnover and might require you to have been trading for a set time, so it’s important to check.
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Chris Lilly is Head of publishing at finder.com. He's a specialist in personal finance, from day-to-day banking to investing to borrowing, and is passionate about helping UK consumers make informed decisions about their money. In his spare time Chris likes forcing his kids to exercise more. See full bio
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