Invoice Financing: Helping Your Business Improve Cash Flow

There are around six million small businesses in the U.K. Are you at the helm of one of them?

If so, you might not have all of your financial details ironed out just yet. Your debts are mounting and your suppliers are waiting for payment, but your clients are dragging their feet and the cash flow just isn’t there.

When this is the case, invoice finance can offer you a way out and sell your unpaid invoices.

Today, we’re taking a closer look at how this process works and the ways it can help your small business stay out of the red, keep your stakeholders happy, and grow your bottom line.

Ready to learn more? Let’s dive in.


What is Invoice Financing?

In short, invoice financing is the process of selling your unpaid invoices to a third party. For a small fee, this third party advances you some of the cash that’s tied up in those invoices so you can pay your suppliers and keep your stakeholders happy.

Why would you need to do this?

Adequate cash flow is the key to growing your business. When you have plenty of money coming in to fund your ongoing expenses, you can stay in the black and move forward. However, this equilibrium assumes that all of your clients will pay their invoices on time. 

What happens when those invoices go unpaid and there isn’t enough cash every month to meet your financial obligations? You can’t exactly stop fulfilling new orders or making important business repairs, even if your past customers haven’t gotten around to paying you yet.

The moment your expenses surpass your income, your hands are bound. You might have big dreams for your team’s future, but often, long-term visions can’t get off the ground without short-term funding. 

Invoice funding allows you to shift the burden of your outstanding, unpaid invoices off your shoulders. Now, you don’t have to wait three months to receive payment from your tardy clients. You’re free to unlock that tied-up capital as soon as possible.

Not only does this free you up to focus on mission-critical work, but it also gives you access to cash that you can use to settle your debts, pay your suppliers and keep your business operating as normal.

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How Does Invoice Financing Work?

Individual providers will have their own terms and rates. You can find some who will advance you up to 95% of the value of your combined unpaid invoices. This can go a long way toward helping your business keep its doors open while you work to reclaim your financial stability.

In general, there are two main types of invoice financing:

  • Invoice factoring
  • Invoice discounting

Let’s take a look at each option in greater detail.

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Invoice Factoring

With invoice factoring, you’ll sell your unpaid invoices to a finance company. This company is often called the “factor”.

The factor will turn around and advance you the money that you’re owed. They’ll do so before they even begin collecting the balances on the invoices themselves. Once the invoice is paid, you’ll receive the outstanding balance that remains.

While you’ll have to deduct fees from this amount, they’re often minimal and worth the freedom and flexibility you’ll receive. Most fees range from 0.5% to 5% of the invoice value.

When they go this route, most business leaders decide to hand-select which invoices they hold back in their office, and which ones they send to the factor. The finance company then assumes administrative control over the ones that it does receive, collecting client payments and performing credit management duties from that point forward.

While this can be a great relief, it does come at a slight price.

As your factor now controls your accounts, that company will interface with your clients on your behalf. That means there’s no hiding from the fact that you chose to borrow in this way. The only workaround is that some invoice factoring companies will agree to operate under your business name, allowing you to use your normal invoice collection procedures. 

Is It For Me?

Invoice factoring works best for small business owners who don’t have sophisticated payment collection procedures or adequate credit control, allowing you to sell your unpaid invoices. With this setup, your factor is responsible for chasing your outstanding payments, not you.

Invoice Discounting

Invoice discounting puts a slightly different spin on invoice factoring.

With this process, the lender will still advance you a certain percentage of the outstanding invoiced amount you’re due. Normally, invoice discounting lenders will only accept invoices that are 90 days old or older.

The main difference? The lender never assumes administrative control of your accounts and doesn’t perform any credit management duties. Instead, you’re still the one who manages your client accounts and receives the eventual invoice payments.

When you do receive a payment, you’ll deposit it into a client account associated with the discounting lender. In turn, the lender will pay you the leftover balance from the invoice, minus fees for borrowing charges.

Most of the time, your cash advance can be higher and your associated fees are smaller with invoice discounting than invoice factoring. Another benefit of choosing this option? You can keep the process confidential, as you aren’t required to tell any of your customers about your actions. 

While it can feel cumbersome to pay a fee to a lender while still shouldering all of the responsibility, keep in mind all of the perks that this plan provides. 

Is It For Me?

Invoice discounting works best in large corporations, where there an advanced debt collection system is already in place. For that reason, many invoice discounting providers will only work with companies that boast a high enough turnover and a positive balance sheet. You might also go this route if borrowing anonymously and maintaining your brand reputation are key considerations.

How to Choose an Invoice Finance Provider

While it’s tempting to just close your eyes and choose the lender that offers you the greatest cash advance, there are other factors to consider before you sign on the dotted line. In some cases, a lender will advertise an attractive 90% advance, but it carries heavy stipulations in the background, including a requirement to purchase credit insurance.

Ultimately, you want a provider that has an excellent reputation for client negotiations. They should have a healthy customer base, but not one that’s so big you’ll fall through the cracks and feel like just a number. 

While you’re doing your due diligence and shopping around for quotes, pay close attention to the total cost of the invoice finance. There are several factors that will determine this number. Let’s take a look at a few of the most important ones.

Invoice Value

Each invoice will normally have its own fee attached. Those that are smaller will have smaller fees, and vice versa.

Frequency of Access

Most lenders will allow you to finance just one invoice. This is a process known as spot factoring. However, it pays to finance more than that if you want to lower your associated fees. 

In general, the more invoices you hand over to your lender to release funds from, the lower your fees should be.

Your Industry Sector

Lending to any commercial client means that an invoice financing company assumes the risks associated with that niche. It goes without saying that some industries are inherently riskier than others.

As such, businesses that operate in high-risk sectors (e.g. construction, manufacturing, healthcare) are usually required to pay higher fees than others. 

Client Reliability

If you choose invoice factoring, it’s smart to be strategic with the invoices you send over. For instance, if you have a client that’s reliable and always pays on time, you shouldn’t need third-party assistance to collect those funds. 

At the same time, you don’t want to only send over your most difficult clients. Some arrangements will require you to pay back the advance if an invoice never gets paid. Most finance providers will charge lower fees for reliable companies they know have a solid track record of paying on time.  


Reap the Benefits of Invoice Financing and Free Up Cash Flow

You shouldn’t feel stuck in limbo just because your clients aren’t up to speed on their payments. 

With invoice financing, you can maintain operational stability and keep up with new customer demands, even while you wait to collect on your outstanding payments. Whether you go with invoice factoring or invoice discounting, this borrowed cash can help you regain your financial footing, generate more sales and better regulate your cash flow.

To learn more about commercial finance solutions, get in touch. We’re an experienced team of brokers ready to help you make the right decision for your growing company. Let’s take that next step forward together, starting today.

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