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What is invoice financing? How does it work?

Invoice financing is a form of short-term borrowing that allows you to receive a cash advance on your clients’ unpaid invoices. Read our guide to learn more.

6 min read

If your business is experiencing cash flow problems, invoice financing could be the short-term finance solution you’ve been looking for. In this blog post, we’ll explain what invoice financing is, how it works, how much it costs and if it could be a good fit for you and your business.

What is invoice financing?

Very simply put, invoice financing is the process of turning outstanding invoices that you have issued to your customers into cash. Rather than having to wait for 30, 60 or even 90 days (depending on your terms) for a customer to make a payment, just send a copy of the invoice to your invoice financing provider. They will give you a cash advance, typically worth 75-90% 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 to make payments, you have the money to operate on a day-to-day basis and capitalise on opportunities when they come along.

How does invoice financing work?

The key benefits of invoice financing 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 process works:

  1. You send an invoice to your customers as usual

  2. You send a copy of the invoice to your invoice finance provider 

  3. They pay you a cash advance worth an agreed percentage of the invoice’s value (this varies from provider to provider)

  4. You collect the payment from the customer as normal or the provider will do that for you (depending on the type of agreement you have in place) 

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

Types of invoice financing

There are two main types of invoice financing. Although they are similar in that they both release funds from unpaid invoices, there are some important differences between them.

  1. Invoice factoring: In an invoice factoring arrangement, a factoring company takes control of a business’s sales ledger and credit control process for an ongoing basis over a fixed term, typically 12-24 months. During that time, the factoring company provides an upfront payment to you every time an invoice is sent to a customer. The factoring company is responsible for collecting the payment from the customer when it is due.

  2. Invoice discounting: Invoice discounting is more flexible as you can pick and choose which outstanding invoices you’d like to receive an advance on. You also remain responsible for credit control and collecting the payment from your customers. That can help to maintain the good relationships you have with them.

What is the difference between invoice discounting and factoring?

Both invoice discounting and factoring are potential solutions to dealing with slow cash flow. However, there are some crucial differences in the way the deals are structured.

Invoice discountingInvoice factoring
Invoice discounting
Fees1% to 3% per month The fees involved tend to be less than invoice factoring because you retain responsibility for your own credit control and collections
Typical initial advance80% of the invoice’s value
Who collects the payment?Your business
ContractsFlexible agreements on a contract or pay-as-you-go basis
ConfidentialityYou retain responsibility for credit checking customers and collecting payments, so the deal can remain confidential

Is invoice financing a good idea for a business?

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

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 have to buy stock and pay staff while they wait for payments to be made by their customers are particularly well suited to this type of funding.

Another benefit of this type of funding is that it’s 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.

However, one of the downsides of invoice financing is that you’ll lose a percentage of your turnover every month. That means it’s only a viable solution for businesses with healthy profit margins that can sustain this loss.

What does invoice financing cost?

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: This is the fee to begin the process. This fee is not charged by all providers and will vary between industries.

  • Discount charge: Generally speaking, the higher the value of the invoice you want to get an advance on, the lower the discount charge will be. This can range from 0.5% to 5% of the invoice’s value.

  • 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. These fees can range from 0.2% for invoice discounting to 2.5% for factoring.

How can I get small business invoice financing?

The good news is that invoice financing is available to small businesses with less-than-perfect credit records. The most important thing is the creditworthiness of your customers. 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 balance of the invoice is collected.

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Is invoice financing right for you?

Invoice financing is a fast and flexible form of funding for businesses that experience short-term cash flow problems.

However, it is not the only form of funding that can help. You should explore all of the traditional and alternative finance options available to you and consider consulting an expert if you need advice.

QuickBooks can help you create invoices quickly and get paid faster - check out our invoicing services for small businesses to learn more.

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We hope you’ve found this article about invoice financing useful. If you want to learn more about invoicing, visit our small business blog.