What is invoice factoring and how does it work?

If you’re dealing with slow commercial invoice payments, invoice factoring could be the answer. Get access to more cashflow when you need it, so you can put it where it matters. Reduce time spent waiting for payments by selling customer invoices in exchange for quick access to cash. 

Read on to learn more about what invoice factoring is, how it works and how it could help improve cash flow for your business.    

Invoice factoring: In summary

• Invoicing factoring involves selling your unpaid invoices to a finance provider who takes control of your sales ledger.

• Since the provider handles collections directly, the arrangement is visible to your clients – something to consider in terms of external relationships.

• While invoice factoring can provide early access to customer payments, it’s important to evaluate service fees to confirm your profit margins can sustain the arrangement. 

What is invoice factoring?

Invoice factoring is a type of invoice financing that allows businesses to access cash tied up in unpaid invoices without taking on long-term commercial debt. This effectively means a business ‘sells’ its invoices to a factoring provider at a discount in exchange for a cash advance. Instead of waiting 30 to 90 days for clients to pay, you can access a certain amount of the cash within 24-48 hours.

How does invoice factoring work?

Invoice factoring allows businesses to sell invoices at a discount in return for a cash advance. Here’s how the process works:

1. You raise and send a standard sales invoice to your commercial customer.

2. You pass a copy of that invoice to your chosen invoice factoring provider.

3. The provider verifies the invoice and pays you an upfront cash advance, up to an agreed percentage of the invoice's value.

4. The factoring company takes over your credit control process and collects the full payment directly from your customer when it hits its due date.

5. Once the customer settles the bill, you receive the remaining balance of the invoice, minus any administration and management fees owed to the provider.

Advantages of invoice factoring

Wondering if invoice factoring is right for your business? Let’s explore some of the key advantages. 

• Immediate cash flow: Rather than waiting for customers to pay, invoice factoring lets you access up to 90% of the value of an invoice within 24 to 48 hours. These funds can help keep your day-to-day operations running and also allow you to pay staff.

• Outsourced credit control: Saves your business administrative time and energy as the factoring company manages your sales ledger and handles collections.

• Accessible to small businesses: Providers check the creditworthiness of your commercial buyers rather than your internal credit records, making invoice factoring an option for small businesses that don't qualify for a bank loan.

• Scalable limits: The more invoices your business generates, the more capital you can access, meaning you don't have to keep extending a standard overdraft as your sales expand.

Invoice factoring vs invoice discounting: the key differences

Invoice factoring and invoice discounting are both a subset of invoice finance solutions designed to release cash tied up in customer invoices. But there are some key differences between the two. Understanding the differences between invoice factoring vs invoice discounting can help you dictate which method is best for your business. 

Credit Control Ownership

• In an invoice factoring arrangement, the finance provider manages your credit control and collections. 

• With invoice discounting, your business retains full responsibility for collecting customer payments. This includes chasing any late payments. 

Confidentiality Boundaries

• With invoice factoring, customers pay their invoices directly to your chosen factoring provider. This means customers will know you are using an external financing business.

• Invoice discounting remains completely confidential because you handle your own ledger behind the scenes.

Contract Formats and Fees

• Invoice factoring typically involves longer-term contracts (typically one to two years, or sometimes longer) and higher management fees because the provider handles the ledger administration. 

• Invoice discounting offers more flexible agreements and lower fees as you handle payment collection yourself. 

Things to consider before signing an invoice factoring agreement

While there are several advantages of invoice factoring, there are some potential downsides and administrative hurdles to consider before signing an agreement.

Firstly, since you lose a percentage of turnover to discount charges and admin fees, invoice factoring is only a viable solution for businesses with healthy profit margins that can sustain this loss.

Secondly, while specialised ledger systems track your advances, they don't run your final tax returns or submissions. This means you’ll need to carry out these tasks yourself to stay compliant with HMRC.

Keep your financial records in good shape with QuickBooks

While QuickBooks isn’t a funding provider, it can help with compliance and prevent manual spreadsheet errors by keeping your customer invoices, ledger statements and cash flow tracked on its cloud platform, making tasks like invoice numbering easy. This can help keep your records organised if you go on to apply for a factoring facility. 

Discover QuickBooks invoicing software.

Invoice factoring FAQs

Will my customers know that I am using an invoice factoring service?

Yes. Because the factoring provider collects payments directly from customers, your customers will know you are using an external provider. If you wish for this information to remain confidential, you might want to consider invoice discounting instead. 

Does receiving a factoring cash advance change my VAT reporting responsibilities?

No, receiving a factoring cash advance has no effect on your VAT reporting responsibilities. Calculating and reporting VAT on your regular submissions remains the same, so all transactions must be logged accurately with your software. 

What is the main difference between invoice factoring and invoice discounting?  

Invoice factoring and invoice discounting both let you access cash tied in your customer’s invoices. The main difference between invoice factoring and invoice discounting centres around credit control. With invoice factoring, the collection duties and ledger management is passed over to the provider. With invoice discounting, your business is responsible for chasing payments. 

Is invoice factoring worth it?

Invoice factoring could be valuable to your business if you’re looking for a way to quickly boost your cash flow. Rather than waiting around for payments, you could advance up to 95% of the value of your customer’s invoices. However, there are potential drawbacks to consider before deciding if its right move for your business. 

What are the disadvantages of invoice factoring?

One of the main disadvantages of invoice factoring is that customers will know you are using an external provider. This could potentially affect customer relationships and may lead them to assume you’re in financial hardship. Other disadvantages include high fees and long contracts.

The information on this website is provided free of charge and is intended to be helpful to a wide range of businesses. Because of its general nature the information cannot be taken as comprehensive and they do not constitute and should never be used as a substitute for legal, accounting, tax or professional advice. We cannot guarantee that the information applies to the individual circumstances of your business. Despite our best efforts it is possible that some information may be out of date. Any reliance you place on information found on this site or linked to on other websites will be at your own risk.

This information is intended to outline our general product direction, but represents no obligation and should not be relied on in making a purchasing decision. Additional terms, conditions and fees may apply with certain features and functionality. Eligibility criteria may apply. Product offers, features, functionality are subject to change without notice.