Invoice Finance: What is it? And How Does It Work? - An Essential Guide for UK Businesses
In today’s fast paced business world, managing cash flow effectively is crucial for survival and growth. This is where invoice finance can help, offering an immediate working capital boost to businesses waiting on unpaid sales invoices. In this essential guide, we will explore what invoice finance is, how it works, and why it might be the cashflow solution that your business needs.
What is Invoice Finance?
Invoice finance is a financial solution that allows businesses to unlock the value of their unpaid invoices whilst offering their trade customers credit terms.
It is a way of monetising invoices due in 30, 60, or even 90 days. This method of finance can be particularly beneficial for small to medium-sized enterprises (SMEs) that face cash flow challenges due to delayed payments.
Types of Invoice Finance
There are four main types of invoice finance available in the UK:
- Invoice Finance (aka Invoice Factoring): This involves a business selling its invoices to an invoice finance company who then advance a significant portion of the invoice value (up to 90%) immediately to the business. The invoice finance company will also provide sales ledger management to the business which includes the collection of payments from its customers when due, making it a suitable option for smaller businesses or those looking to outsource their accounts receivable management.
- Invoice Discounting: In this arrangement, the business retains control over its sales ledger and continues to manage customer payments. The invoice finance provider advances a percentage of the value of the outstanding invoices, in the same way as invoice finance. However, since the business maintains control over the collection process, invoice discounting is often preferred by larger companies with established credit management processes.
- Selective Invoice Financing: Selective invoice finance is a type of invoice financing where a business has the flexibility to choose specific invoices or accounts to finance, rather than having to finance their entire sales ledger. Selective invoice finance can be an attractive option for businesses seeking to manage cash flow more effectively without the commitment of financing their entire book of receivables.
- Confidential Invoice Discounting: Confidential invoice discounting is a version of invoice finance where businesses can borrow money against their unpaid invoices without their customers being aware of this kind of secured funding arrangement. It is a discreet financial solution that provides businesses with the benefits of improved cash flow on a confidential basis.
How Does Invoice Finance Work?
- Sales Invoice Created: Once you have provided goods or services, you issue an invoice to your customer in the normal course of business.
- Invoice Assignment: You then “assign” the invoice to an invoice finance provider under a debt purchase “invoice finance” agreement
- Upfront Payment: The invoice finance provider advances you an agreed percentage of the invoice’s total value within a brief period (either immediately or within 24 hours)
- Payment Collection: Depending on whether you have chosen an invoice finance or invoice discounting solution will determine whether you or the finance provider will undertake credit control to collect the payment of the invoice from your customer when it falls due.
- Receipt of Balance: Once the customer pays, you receive the remaining balance of the invoice, minus any fees or charges.
Benefits of Invoice Finance
- Improved Cash Flow: Immediate access to funds tied up in invoices.
- Growth and Stability: Provides the financial stability and cash flow necessary to grow your business.
- Timesaving: With invoice finance, the funder will undertake your sales ledger administration, saving you time and resources to allow you to focus on other aspects of your business.
- Flexibility: Adapts to your business’s changing needs and funding requirements.
Considerations for UK Businesses
- Costs: As with any financial commitment, be aware of any contractual fees and interest costs of money advanced.
- Customer Relationships: Consider how invoice finance and the existence of a “third party” might impact the relationships that you have successfully built with your customers.
- Eligibility: Ensure that your business and the nature and composition of your invoices meet the underwriting criteria set by finance providers.
Frequently Asked Questions about Invoice Finance
What is an invoice finance company?
Invoice finance companies enable businesses to unlock immediate cash from their outstanding invoices. Rather than waiting for clients or customers to pay their bills, businesses can transfer their unpaid invoices to an invoice finance company for a small fee.
This flexible solution empowers businesses by accelerating their access to cash, which is crucial for managing working capital and daily operations, meeting weekly and monthly wage bills, and covering essential trade creditors. Invoice financiers can also provide full sales ledger management to the business including professional credit control and administration.
Is Invoice finance in the UK suitable for small businesses?
Yes, invoice finance can be suitable for small businesses in the UK, offering many benefits from a funding and growth perspective.
- Improved Cash Flow: Small businesses often face cashflow challenges due to delayed payments from customers. Invoice finance provides an immediate funding injection which can stem, alleviate and boost cashflow.
- Growth and Expansion: Access to immediate and continued cashflow gives small businesses the funding peace of mind to embrace growth opportunities, like taking on larger orders or expanding its operations, without the cash constraints typically caused by slow-paying customers.
- Reduced Credit Risk: Some forms of invoice finance such as non-recourse, come with the added benefit of credit protection against the non-payment of debt due to customer insolvency or protracted default.
- Timesaving: Managing customer payments can be time-consuming. With invoice finance, the responsibility of chasing and collecting payments is transferred to the finance provider, freeing up valuable time for small business owners to focus on core activities.
- No Need for Collateral: Unlike traditional bank loans, which often require collateral, invoice finance is secured against the invoices (“the debt”) themselves. This feature makes it more accessible for small businesses that may not have significant balance sheet assets to offer as security.
- Flexibility: Invoice finance is typically more flexible than traditional loans and grows in line with sales turnover.
- Ease of Qualification: It can often be easier for small businesses to qualify for invoice finance compared to traditional bank loans, as the key underwriting focus is on the “debt” being offered and the creditworthiness of their customers, not on their own credit history or financial standing.
Are invoice finance brokers regulated in the UK?
Invoice finance services are not currently regulated by the FCA (Financial Conduct Authority). However, to ensure integrity and a fair service is provided, UK Finance, its governing body have an industry-wide accredited code of conduct.
What charges can I expect with invoice finance?
As with any form of external funding, there are costs associated with invoice finance and these can differ from one provider to the next. Standard charges include:
- Service Fee: This is a charge for administering the invoice finance facility and is often calculated as a percentage of your turnover.
- Discount Charge or Interest Rate: Similar to interest on a loan, this charge is applied to the money advanced to you and is typically calculated as a percentage over the Bank of England base rate.
- Set-Up Fee: Some providers may charge an initial fee for setting up the invoice finance arrangement.
- Credit Protection Fee: If you opt for a facility that includes the benefit of debtor protection (to safeguard against non-paying customers), there will be an additional cost applied.
- Facility Charges: Depending on the type of facility offered and the agreement that governs it, there may be other fees applied throughout its term. These can include audit fees, operational fees, and fees for early termination of the contract.
It is therefore advisable to fully review the terms and conditions of any invoice finance agreement with the provider to ensure clear transparency and to understand its fee structure before deciding to move forward.
Why should I use an invoice finance provider instead of my bank overdraft?
Invoice finance is very flexible. As your turnover grows so does your access to funds. You do not need to negotiate new terms with an invoice finance provider as the facility is sales led. We know that our underwriting and onboarding journey is much quicker than a bank, injecting cash into your business almost immediately instead of having to wait days or even weeks.
What if I do not want my customers to know that I am using invoice finance?
Invoice finance companies can offer a service known as confidential invoice discounting. This enables you to preserve your trusted customer relationships, as an invoice funder’s involvement remains undisclosed to them.
Invoice finance can be an extremely portable and flexible solution for healthy cashflow and for supporting business growth.
The key to successful use of invoice finance is choosing the right provider and understanding the terms of the funding arrangement. With the correct solution, invoice finance can help your business navigate through its cashflow challenges and provide you with the funding peace of mind to take advantage of growth opportunities.