In 2017, over 60% of invoices raised by small and medium-sized enterprises (SMEs) and accounting for £21 billion worth of business were paid late. While larger organisations might have the working capital available to cover any shortfalls from late payments, for SMEs, this can be the difference between success and failure, which is where invoice financing comes in as it provides smaller organisations with a way to cover shortfalls in cashflow or invest in growth.
There are two main types of invoice financing available in the UK: invoice factoring and invoice discounting. Both allow companies to borrow against unpaid invoices, with financial institutions – including banks and building societies – offering short-term loans to up to 95% of the value of invoices.
While the terms are sometimes used interchangeably, invoice discounting tends to be used for one-off loans, invoice factoring for ongoing borrowing. If businesses plan on regularly borrowing against invoices, they’ll need to set up an account which may include additional, monthly, administration charges.
Invoices need to be submitted to the lender as soon as they are raised. They cannot be overdue.
In order to be eligible for invoice factoring or invoice discounting, you’ll need to be a business to business (B2B) company, meaning you sell to customers rather than consumers. Every lender will have a different set of eligibility requirements beyond this. In general, however, you’ll need to have:
- An annual turnover of at least £25,000
- Credit terms between 30 and 90 days
- Customers based in the UK.
Lenders will want to understand the number of invoices you issue, how regularly these invoices are raised and the size of your customer base. Invoice factoring tends to work better when you raise a higher volume of invoices, whereas invoice discounting is a better option for those with fewer customers.
Pros and Cons
There is a range of pros and cons when it comes to both invoice factoring and invoice discounting including:
- You can get immediate access to cash based on the value of your invoices – up to 95% of their total value.
- You can better manage your cash flow.
- Your invoices act as collateral so there’s no need to use your assets as security and you’re more likely to get approved.
- There are a number of fees that need to be paid including administration, late payments, bank transfers and processing. These can add up and be much higher than the interest you’d pay on a traditional loan.
- If your customers don’t pay their invoices, you may be required to pay back the money you’ve borrowed, which could be a problem if you no longer have it in the bank.
With invoice factoring, there are two additional downsides it’s worth bearing in mind:
- Lenders can carry out credit checks on your customers before accepting invoices. This means customers will know you’re using invoice factoring, which could lead to reputational damage.
- Your lender takes control of chasing payment on outstanding invoices. They may not take as ‘softly, softly’ an approach as you would with customers, which could harm your business relationships.
With invoice discounting, you keep control of your invoices, meaning you keep your financing arrangements private, and can maintain positive relationships with your customers, choosing how and when to chase them for payment. However, it relies on your ability to convince customers to pay; if you aren’t comfortable chasing for money, you may want to have your lender do it for you.
With both options, you choose how many invoices to submit to the lender, meaning you only have to submit enough to cover the amount you want to borrow. However, if the majority of your invoices are higher in value and you only need a small amount of cash, you may find yourself paying more in fees than you would through others forms of financing.
The application process
The application process for both invoice factoring and invoice discounting is basically. However, with invoice factoring, the lender could carry out credit checks on your customers. They are unlikely to do this with invoice discounting.
For both, you’ll need to provide an overview of your company, your accounts receivable aging report and information on any tax liens or liens against your invoices.
Each lender will have a slightly different application process and require slightly different types of documentation. Look for ones with clear and transparent processes and easy to understand fee structures as well as a good reputation for customer service.
The financing process
Once you’ve been approved, for both invoice factoring and invoice discounting:
1. You invoice your client
2. You submit your invoice(s) to the lender
3. The lender verifies the invoice(s)
4. The lender pays you the agreed advance
5. Your customer pays the lender
6. The lender pays you the remaining value of the invoice(s) minus any fees.
With invoice factoring and invoice discounting, you will be charged fees for:
- Setting up your account
- The period of time between you borrowing the money and your customer paying their invoice; this is known as a Discount Fee.
For invoice factoring (and invoice discounting if you plan on submitting invoices regularly), you will be charged a monthly management or administration fee.
Invoice factoring also includes a Factor Fee which covers the costs to the lender of chasing outstanding invoices. Factor fees are normally calculated as a percentage of the total value of your invoices.
Fees and charges vary across lenders, so it’s a good idea to shop around before deciding which to go with. Remember, however, that the final fees you are charged (which will be outlined in an agreement between yourself and the lender) will depend on several factors. These include your annual turnover, the number of invoices you plan on submitting, whether you’ll be submitting invoices every month or as a one-off and your credit rating (along with that of your customers in the case of invoice factoring).