Invoice Finance
Invoice Finance and Factoring are ways to borrow money based on the amounts due from business’s customers, i.e. their debtor book. It helps businesses improve their cash flow, pay their bills and reinvest, earlier than they could if they had to wait until their customers paid them. Facility can generally raise up to 90% of the invoice values. Factoring also involves the option of credit control.
Types of Invoice Finance
Understanding the right type of invoice finance for a business depends on the business size, current situation, requirements, preferences, and objectives.
What is Invoice finance?
This is when a lender uses an unpaid invoice as security for funding, releasing a percentage of the total invoice quickly to aid cashflow.
It is suitable for many small or medium-sized companies with B2B (Business to Business) customers being paid by invoice in 14 days or more.
The amount of money a lender will provide is based on their own risk guides.
There are two main types of invoice finance:
- Invoice factoring
- Invoice discounting
There are also a number of specialist and subsectors of the two main factors, the most well known being selective invoice finance.
Invoice factoring
Invoice factoring allows businesses to generate money against unpaid invoices and the lender can lend upto 90% of the value of the invoices.
Factoring involves the company selling their sales ledger to the lender or “factor” who collects the unpaid sums direct and manages the sales ledger.
It will then deduct the costs of the factoring service, before paying over the remaining balance.
Some of the characteristics of invoice factoring include:
- being generally easier for smaller businesses to secure
- the factoring provider credit checking potential customers
- unlike invoice finance which is confidential, customers will know that the business is using an invoice factoring provider.
Invoice discounting
This works like factoring, but an important difference is that the business retains control of its sales ledger.
It involves a fee and a discount charge (like interest) if the funding is used, rather like a standard overdraft.
Invoice discounting is, unlike factoring confidential. The responsibility for credit checking customers remains with the business, as is the responsibility for ensuring customers pay on time.
In general, invoice discounting is more often used by more established businesses with larger turnovers.
Selective invoice finance
In addition to invoice factoring and invoice discounting, there are a number of other types of invoice finance.
Selective invoice financing provides the flexibility to finance selected customer accounts, whereas spot factoring gives the option to finance distinct invoices.
These methods differ from factoring and discounting as they are not comprehensive solutions; they offer the choice of determining which invoices to finance while managing the remaining ones in a typical manner.
Advantages & Disadvantages
There are a number of advantages and disadvantages to be borne in mind before using invoice finance namely:
Advantages
-
Maximising assets – using unpaid invoices as security, businesses can capitalise on unused assets on their balance sheet.
- Flexibility – most businesses who meet the minimum criteria can apply, and little controls on how the funds raised from invoice finance are spent.
- Cashflow – funds available quickly and can scale with business and its turnover, invoice finance can keep cash flow healthy.
- Security – The unpaid invoices serve as the security eliminating the need for additional security.
- Confidential – Invoice discounting is confidential – the customer is unaware of the facility.
- Efficiency – Companies that provide invoice factoring essentially function as credit controllers for the business.
Disadvantages
- Credit Profile -Invoice finance providers will conduct credit checks when a business applies for invoice finance which could have an impact on the credit report.
- Privacy – Factoring involves the credit control process being handled externally which may impact how the business is viewed by their clients. this does not apply to invoice discounting.
-
Costs – using Invoice finance services involves fees whilst if factoring is utilised interest rates and processing fees charged by the lender needs to be considered.
- Customer dependence – Depending on the terms set by the lender, you may be held responsible if your client fails to settle their invoice.
FAQs
What type of business is eligible?
As with all financial products, there are a number of eligibility criteria to be met to qualify to use invoice finance.
- Financial statements – The lender will review these to establish a solid trading history
- Invoice terms – each lender will have their own criteria but generally they will not consider terms over 90 days
- History of good customer payments – the lender will review customers and their paying habits, and look for those who pay invoices on time with a strong credit rating
- Trading with B2B – Invoice finance is normally only available to businesses that trade with others (known as business-to-business, or B2B).
What costs need to be considered?
There are different costs applicable to Invoice financing and invoice factoring.
Invoice financing costs: There is an interest charge and credit management fees, which are generally billed monthly. Interest rates can range from an average of 1.5% to 3% over base rate and are calculated daily. The credit management fees vary from an average of 0.25% to 0.5% of turnover. There may also be other costs.
There is a risk element which is considered in pricing, consideration is given to, credit-worthiness of customers, the length of time they take to pay, and the business’ credit history.
Invoice factoring costs:
Factoring costs are called the factor rate. which is based on the level of risk, (customer default on invoice) and the volume of invoices (high volume = cash value higher)
- The lower the risk and the greater the volume, the lower the factoring costs
- The higher the risk, and the lower the volume, the higher the factoring costs.
As the factor agent take over the company’s sales ledger and essentially acts as credit controller chasing customers for payment, the administration costs are higher than those for invoice financing.
Is Invoice discounting a loan?
Yes. The unpaid invoices are used as security for the borrowing. This is a key difference between discounting and factoring; where a business sells its invoices to a factor agent for a discount on the total whilst invoice finance lenders provide a loan facility. In this case they recoup the loan and their fees at source, taking repayment direct from the business customer.
Next Steps
Trying to find the most suitable type of invoice finance, identifying the lowest interest rates, and finding the perfect lender for your specific business circumstances can be a labour-intensive and time-consuming process.
Therefore it’s a good idea to seek independent, specialist financial advice before deciding on the right type of finance to apply for.
For an initial no obligation call or meeting, please contact us to arrange.