The invoice finance umbrella covers a variety of options, each designed to unlock capital tied up in unpaid invoices. Invoice factoring is one of these options.
With many SMEs struggling with late payments and the knock-on effects on cash flow, invoice factoring has proven a valuable tool in alleviating the pressure.
However, what does invoice factoring entail? How do you know if it’s right for your business?
Our brief guide will answer all your questions by explaining the ins and outs of invoice factoring.
- What is invoice factoring?
- 5 benefits of invoice factoring
- What to bear in mind
- How to access invoice finance
What is invoice factoring?
Invoice factoring is a form of finance that uses your unpaid business to business invoices as security. It releases as much as 90% of the value of your invoices. The funding given may be used anywhere in your business, including to fuel growth.
It offers a quick release of money, meaning you will quickly address cash flow gaps. The loan term typically ranges between 30 and 120 days (either from the invoice date or month end), giving you longer to recoup customer payment.
Factoring shares many characteristics with invoice discounting. However, some crucial differences set the two apart.
In a factoring arrangement, your customers will repay the lender rather than you. You are removed as the middleman and will not have to pass payment over as it is done directly.
In most cases, the lender will chase payment on your behalf, which reduces the time and effort many SMEs spend contacting customers to seek missed payments.
It is possible to use invoice factoring across single, selective or across all your invoices as part of a facility. This will give you ongoing access to finance as the size of your aged debtor ledger grows. It will also allow you to negotiate better rates with a lender the more you have to leverage.
5 benefits of invoice factoring
There are many advantages to invoice factoring. We’ve listed them below.
It boosts cash flow quickly
The quick release of the money in an invoice factoring arrangement means businesses benefit from a rapid injection of capital when needed.
With cash flow issues often spiralling and leading to worse financial problems, taking swift action is crucial to maintaining stability. Invoice factoring enables you to do this in as little as 24 hours.
It passes credit control to the lender
In most invoice factoring scenarios, the lender takes control of chasing payment. Payment goes directly to them, meaning your role is minimised, and you do not have to spend hours trying to contact customers’ accounts teams.
It’s also worth mentioning that any company the lender uses to recoup payment will be highly experienced in credit control, so they will stand a better chance of securing invoice payments.
It may protect you against non-payment
When using invoice finance, the ideal outcome is that your customers pay you on time, and you then use the money to reduce your total borrowing. However, if your customers refuse to pay, you are left with a cash gap that you will need to fill out of your pocket.
If your loan has a non-recourse agreement, you aren’t liable if the lender cannot get payment from the customer (the lender will cover it instead). A credit protection charge may apply to the funding to protect the lender against this scenario, but it will be less than if you had to cover the loss yourself.
It grows with your business
As your business grows, you will invariably send out more invoices and probably at higher values as well. An invoice factoring facility will expand with your business, enabling you to use your increased invoice volume to drawdown additional funding as you need it.
In some cases, you might be able to negotiate more competitive terms as your facility grows. It is always worth reviewing your lenders offerings to ensure your deal remains competitive.
It will also reduce the risk of bringing in new customers, as you have a way of managing cash flow even if they are late in paying.
It’s highly accessible
Most businesses will be eligible for invoice factoring provided they send invoices to other businesses. Other than a small personal guarantee from the directors, no security is required outside of invoices.
Invoice factoring is also more accessible for companies with lower turnover or higher perceived risk. As the lender has more control and receives payment directly, they are open to many different business sectors. This differs from an invoice discounting agreement, where the lender might only offer funding to those above a specific annual turnover.
What to bear in mind
Alongside the rewards, there are factors to consider. These will help you to determine if invoice factoring is best for you.
It’s not confidential
Unlike invoice discounting, invoice factoring is not confidential. As payments go directly to the lender, you must update your invoices with the lender’s payment details, meaning your customers will know that you are working with a third party.
If you do not wish for your customers to know about the invoicing facility, factoring won’t be a fit for you.
The costs involved
Any form of invoice finance will have costs involved. However, these tend to be higher in an invoice factoring arrangement as the lender has to do more (including chasing payment).
Examples of costs include:
- Credit protection charges – if you have a non-recourse agreement that leaves the lender at risk of customer non-payment
- Service fees
- Interest
- Trust, CHAPS and BACS fees
More about the fees associated with invoice finance is available here. It is worth noting that, even with the charges, invoice factoring remains a cost-effective solution for most businesses and is typically cheaper than an overdraft.
You may be liable for non-payment in some scenarios
An invoice factoring facility is more likely to have a non-recourse agreement than discounting. This means you won’t be expected to cover the loss if a customer refuses to pay or the lender fails to get hold of them.
Not every invoice factoring situation will be non-recourse. In some instances, you will still be liable for non-payment, a risk that you must consider. You must check the specific terms of your agreement to find out which is the case.
The lender will contact your customers
The nature of invoice factoring means the lender needs to contact your customers as well as chasing payment. You will have little to no control over these interactions.
Some firms will feel uneasy handing control of their sales ledgers and credit control practices to a third party. It could lead to a different customer experiences or even relationship damage if people aren’t happy communicating with an external company.
Invoice discounting may be more suitable if you want to retain total control of your customer relationships.
Terms and rates
As with any form of funding, securing a deal that works for your specific needs is vital.
When seeking an invoice factoring facility, you should compare providers to see who offers the best terms and rates for your requirements and invoice methods. It’s also crucial to remember what you can afford to borrow and any preferences you have.
Working with a financial broker is key as they will connect you with the right lenders and secure a suitable arrangement.
How to access invoice finance
By this point, you should have a better understanding of whether invoice factoring is a fit for your needs.
Many options exist in today’s market, including factoring and discounting facilities. This means there is a solution for every business.
If you are seeking invoice finance for your business, Pegasus will help you to find your perfect match.
We start by discussing the unique criteria your business wants to fulfil before presenting the most appropriate lenders. We will then put you in contact with the right people and work with you to negotiate favourable terms.