a guide for small businesses

Invoice financing can be used to quickly access cash while you wait for customers to pay you. Whether you need to pay suppliers or employees, or reinvest to grow your business, invoice financing can be a quick way to boost your cash flow.

If you regularly send invoices for work you’ve done, you know that tracking down overdue invoices and managing your finances while you wait for payment can be difficult.

And depending on your payment terms, it can take 30 days (or sometimes up to 90 days) for a customer to pay you after you issue the invoice.

Here’s how invoice financing can help your business manage cash flow.

What is invoice financing?

Invoice financing allows you to sell your unpaid invoices to a third party, who will then lend you up to 95% of the value of those unpaid invoices.

It’s a short-term business financing option, bridging the gap between bill payments and increasing your cash flow.

As an alternative to getting a business loan, this can be a faster way to access cash. Money can sometimes be available within 24 hours.

But invoice financing is not without long-term risk, so you need to consider whether it’s right for you and your business.

How does invoice financing work?

There are two types of invoice financing. Here is an overview of invoice discounting versus factoring:

1. What is invoice factoring?

The lender will have control over ongoing bill payments and can check the creditworthiness of potential customers, giving you more time to focus on running your business. This means your customers will know you are using a financing provider, so make sure you are happy with the lender’s approach.

Usually, the lender will lend you 70-85% of the bill up front and pay you the remaining amount (less interest and fees) when the customer pays the bill.

An example:

If you have an outstanding bill of £200, you will receive £140 to £170 upfront from the lender, then around £30 to £60, less charges, once the bill is paid.

2. What is the invoice discount?

This is for businesses with higher turnover, giving them more control (but greater administration) as they will be responsible for pursuing payment.

Here you can get an advance of up to 95% of the invoice amount, with the rest paid (less interest and fees) when the customer pays.

An example:

If you have an outstanding bill of £500, you will receive £475 upfront and then the remaining £25, less charges, when the bill is paid.

Financing of individual invoices or customers

Another option is to use ‘select bill finance’ or ‘spot factoring’. This lets you select which invoices and customers you want financing for, so you only use the lender when you need it.

Select invoice financing – choose the customers you want to finance (for example, if you have a customer who regularly does not pay his bills on time).

One-time factoring – choose the invoices for which you want financing (for example, a large project with expensive materials or invoices with longer payment terms).

What are invoice financing charges?

Be aware that there is usually a monthly cost associated with bill financing. Other costs to watch include:

  • postman fee – this cost is for each invoice, normally 1.5-5% of the invoice value

  • credit check fee – if your lender wishes to carry out a background check on you and your clients, the cost varies from 0.2 to 2.5% of gross turnover

  • renewal fees – some companies charge a fee to renew your account at the end of a contract, but many in the UK do not

  • Termination Fee – if you have a contract with a bill finance lender for a certain period, they may charge you if you terminate the contract early (this depends on the size of your bill finance facility)

Benefits of Invoice Financing

Some of the benefits of using invoice financing include:

  • quick access to money – you can get paid as soon as you send your invoice rather than waiting for your customer to pay you (usually within a day or two)

  • no risk to assets – unlike a business loan, invoice financing does not pose a risk to your assets as the loan is based on unpaid invoices

  • opens up investment opportunities – if you are a new business and want to grow your business faster, a cash injection based on unpaid invoices can help you invest and grow faster

Risks related to the financing of invoices

If you’re considering invoice financing for your business, make sure you’re also aware of some of the downsides and long-term implications:

  • your customers must be other businesses – invoice funding is limited to invoices sent to other businesses rather than the general public

  • long term costs – make sure you know the interest rate, processing fees and hidden charges, as these can all add up over time

  • risk of damaging the customer relationship – if you use invoice factoring, you will not have control over the collection of invoice payments from your customers, the lender will. This could potentially harm the trust and relationship you have with your customers

Resources to help you finance your business

You might also find it useful to check out our guides on how to apply for a business loan and how to increase profits.

We also have templates to help you create a budget and a standalone balance sheet.

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