What is invoice financing and how does it work?

If your business is experiencing cash flow problems, invoice financing could be the short-term finance solution you’ve been looking for. Discover more about borrowing money against outstanding invoice amounts to help your short-term cashflow problems.

In this blog post, we’ll explain what invoice financing is, how invoice financing works, as well as the benefits of invoice financing. That way, you can decide if it’s the right fit for your business.

Invoice financing: In summary

• Invoice financing is a short-term finance solution that helps you turn outstanding invoices into immediate cash. This means you can get a hold of money sooner than the 30, 60 or 90 days you’d wait for client payments.

• There are two main types of invoice financing – factoring and discounting. Both can help you to secure funds earlier; the main difference is in who retains control over your daily credit management and client collections. Factoring gives control to the invoice financing company, whereas discounting lets you retain control.

•  While financing advances your funds, it’s still important to keep your records unified on a single digital platform to ensure your underlying bookkeeping remains accurate. Although invoice financing eats into your profit margins, your VAT reports to HMRC do not change and you should track all your regular payments. 

Invoice financing: Meaning and definition

It may sound complex but, put simply, invoice financing is the process of turning outstanding invoices that you have issued into cash. Think of it as borrowing against an owed amount. Let’s break it down with an example of how it works:

• Rather than having to wait for 30, 60 or even 90 days (depending on your terms) for a customer to make a payment, you can send a copy of the invoice to your invoice financing provider.

• Once received, your provider will give you a cash advance, typically worth a proportion of the invoice’s value, within as little as 48 hours. 

That means that rather than being strapped for cash while you wait for customers or clients to pay, you have the money in hand in a matter of days. This way you can continue to operate on a day-to-day basis and capitalise on opportunities when they come along.

So, the meaning of invoice financing is quite literal – taking out money against a pending invoice for an immediate return. 

Learn more about invoices with QuickBooks.

How does invoice financing work?

Invoice financing has many benefits, but the most important ones are speed and flexibility. Once you have an agreement with an invoice finance provider in place, you can raise money quickly and pick and choose which invoices you want to receive advances on.

This is how the invoice financing process works:

• Write your invoice, then send that invoice to your customers as usual

• Once done, pass on a copy of the invoice to your invoice finance provider 

• Your invoice financing provider then pays you an upfront cash advance worth an agreed percentage of the invoice’s value

• Payment is collected from the customer when the due date hits (either by your business or the invoice financing provider, as agreed) 

• You receive the remaining balance of the invoice minus the invoice provider’s administrator fee.

Learn more about automating your invoice processing.

Invoice financing vs factoring: the key differences

There are two main types of invoice financing. Both invoice discounting and invoice factoring are potential solutions to dealing with slow cash flow. However, there are important differences in how the deals are structured.

Invoice factoring

To understand what invoice factoring is, it’s best to break things down:

• Invoice factoring providers take over your company’s sales ledger and credit control process over a fixed, long-term contract. 

• Your factoring provider will pay you an upfront advance and handle collection duties with the customer directly.

• This also means that clients will know you’re using a financing business.

This gives you immediate liquidity and frees you from needing to collect or chase payments manually. 

In short, invoice factoring means selling your unpaid invoices to a third party, whereas invoice financing is using your invoices as collateral against a loan.

Invoice discounting

Invoice discounting is another option, providing a more flexible approach as you can pick and choose which outstanding bills to advance cash against.

Compared to factoring, the key difference with invoice discounting is that your business retains responsibility for credit control and customer collections. While that may mean extra work for you, it allows the arrangement to remain fully confidential – your customers don’t need to know. 

For a full breakdown, check our invoice discounting vs invoice factoring table below:

The business benefits of invoice financing

Invoice financing and factoring arrangements have become increasingly popular among UK businesses over the last few years. With bank loans harder to come by, or more expensive to take out, invoice financing allows businesses to unlock the cash tied up in their outstanding invoices without taking on long-term debt. 

Unlocks tied-up capital

These types of arrangements are particularly well suited to industries where long payment terms and late payments are the norm. Businesses such as wholesalers and recruiters that buy stock and pay staff while they wait for their customers to pay invoices are particularly well suited to this type of funding. 

In short, invoice financing allows you to access immediate working capital to run day-to-day operations without accruing long-term bank debt. 

Scalable funding limits

Another benefit of invoice financing and factoring is that they’re scalable. As the value of your invoices increases, so does the advance payment you receive from your finance provider. 

That means you don’t have to keep extending your overdraft or apply for more loans as your business grows, as the amount of cash you can advance scales dynamically alongside your sales volume.

Protects client relationships

Invoice financing allows you to choose a confidential discounting model, ensuring that your client interactions remain unaffected by your financial dealings. Confidentiality is often desirable because it prevents concerns about your company’s financial choices from surfacing. It also allows you to maintain control over how your customers are treated. 

Learn how to process your own e-invoices.

Considerations and costs of invoice financing

There are several fees to be aware of with invoice financing facilities. These differ depending on whether you choose an invoice discounting or factoring deal. Other factors also come into play, such as the size of your business, the sector you operate in and the creditworthiness of your customers.

• Application fee: The application fee is literally the “fee to begin the process”. Not all providers charge this, and its prevalence can vary between industries.

• Discount charge: Generally speaking, the higher the value of the invoice you want to finance, the lower the discount charge will be. 

• Administration/credit management fee: The provider will charge a fee to cover the cost of administration. In the case of a factoring arrangement, a credit management fee will also apply. Credit management fees are typically lower in invoice discounting arrangements, as you retain the responsibility for collecting and managing your customer payments.

Because you lose a percentage of your turnover with invoice financing solutions to things like application fees, discount charges and credit management fees, this solution is more suitable for businesses operating with healthy profit margins. 

Also, you should consider that, while specialised ledger software maps your funding advances automatically, it doesn’t automatically run your final tax returns or submissions. You’ll still need to carry this out yourself to remain compliant with HMRC guidance. 

How can I get small business invoice financing?

Invoice financing is available to small businesses – even those with less-than-perfect credit records. The most important consideration is your customers' creditworthiness. That can make it a viable option for businesses that may not be able to access a bank loan.

To set up an invoice financing arrangement, you should take the following steps:

• Step 1: Shop around and compare the fees of invoice financing providers. Be aware that you will not always receive the headline advance rate or fee.

• Step 2: Submit your application and give details of your invoices to the provider to see if you’re eligible. 

• Step 3: If you are eligible, you will be given a quote and told what your advance rate will be. Read the terms and conditions carefully and look out for hidden fees.  

• Step 4: Once you agree to the lender’s terms, you’ll be able to raise money from your invoices. You will pay the lender’s fee when the invoice’s balance is collected.

Keep your invoicing records organised with QuickBooks

There’s more to invoices than financing – without the right software, you can quickly lose track of what’s owed and by whom. Get your invoices in order and keep your invoicing recognised with QuickBooks. Track your cash flow, organise customer ledgers, and keep your invoices in order on QuickBooks’ cloud-based platform.

Get compliance support and avoid manual spreadsheet errors. Keep your records prepared in case you ever need to evaluate your invoices today.

Find out more about QuickBooks invoicing software.

Invoice financing FAQs

Can small businesses with limited credit records use invoice financing?

Yes, small businesses with limited credit records can use invoice financing. Because providers assess the creditworthiness of a business’s commercial customers over your internal history, it’s an accessible and viable option for small businesses. If you can’t get, or want an alternative to, a bank loan, then invoice financing could be a practical choice.

Does advancing cash on invoices change my VAT reporting dates?

No, drawing down on a cash advance against a raised invoice has no effect on the way you calculate or report VAT on your regular submission. Each transaction should be logged accurately within your software and reporting as normal.

Is invoice financing confidential? 

Invoice financing can remain confidential, but it entirely depends on the framework you choose. Invoice discounting provides privacy, allowing you to manage your own credit control. Invoice factoring, on the other hand, takes that off your plate with the provider handling collections and client contact directly.

Is invoice financing a good idea?

Whether invoice financing is a good idea or not depends on your business’ finances. If you need the cash, don’t want to take out a bank loan, and have healthy profit margins, as well as reliable customers, it can be a great benefit. If unlocking most of an unpaid invoice within 24-48 hours and getting access to immediate working capital is essential for your operations, it could be a good choice.

What are the risks of invoice financing?

Invoice financing isn’t without risks, with one of the most prominent being recourse liability – the repayment of a loan to the lender in the event a client defaults. Additionally, you’ll experience reduced profit margins due to interest or service fees, and potential damage to customer relationships if a third party aggressively chases an unpaid invoice in a way you wouldn’t want associated with your business.

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.