Invoice finance is an important cash flow solution for many businesses. It allows you to unlock capital tied in your unpaid customer invoices, allowing you to keep things running smoothly.
Given the advantages invoice finance offers, it’s no surprise that 45,000 UK businesses use it in some form. However, if you’re considering it for your company, it is crucial to know the ins and outs before you commit.
Our guide explores everything you need to know about invoice finance, including how it works, how suitable it is and what benefits can be unleashed.
- What is invoice finance?
- Why does invoice finance matter?
- The different types of invoice finance
- Who is eligible?
- Advantages
- Things to bear in mind
- How to access invoice finance
What is invoice finance?
Invoice finance provides funding using your unpaid invoices as security. You may raise as much as 90% of the total value of your invoices (though the specific advance against these invoices will depend on the lender and your agreement).
Funding from invoice finance is often released swiftly, sometimes in as little as 24 hours. Once the capital has been advanced, you will have a set amount of time to repay the advance. This tends to vary from 30 to 120 days, either from the date of the invoice or the month end.
As with most forms of debt funding, you will be charged interest as well as administrative fees. However, invoice finance is highly cost-effective, so the interest rates are competitive.
Why does invoice finance matter?
Invoice finance is a popular financial solution, and for a very good reason. Late payment plagues SMEs in the UK, costing them around £684 million a year. It is reported to affect over half of all companies.
Late payment seriously affects cash flow, making financial management much harder. If the issue develops, SMEs may be unable to cover their commitments, leading to disruption and debt.
Invoice finance offers a way to alleviate cash flow pressure. There is also more time to recoup payment from the customer, although the longer it is outstanding the more interest is charged.
The different types of invoice finance
Invoice finance covers a range of options. They all provide funding against unpaid invoices, but there will be some unique differences that might make certain types work best for your business.
There are three main types:
Factoring
Invoice factoring is when payments of your customer invoices goes directly to the lender. Your customers will know you are using factoring, as the lender’s details will be disclosed on your invoices.
The lender will also have control of your sales ledger and credit control processes. They will chase payments from your customers. This saves you time and effort having to do it, but you will be charged and it does mean you lose some control.
In some cases, factoring arrangements will include a non-recourse agreement in which you are not liable if the customer doesn’t pay. This prevents you from having to pay back funds advanced when a client defaults.
As the lender’s role is more significant in the process and the risk is higher (especially if a non-recourse clause is set), factoring tends to be more expensive than other types of invoice finance. However, it still offers value for those who don’t want to chase customer payments or those who have lower turnover where the other options may not be available.
Confidential invoice discounting
In an undiclosed invoice discounting scenario, your customers continue to pay into a new trust account put in place by the lender. You retain control of your customer relationships and will be responsible for chasing unpaid invoices to maintain consistent customer experiences.
Invoice discounting is ideal for businesses that want to retain privacy and not inform their customers that they’re using an external finance facility.
It also tends to have fewer costs associated as the lender has a less prominent role.
Disclosed discounting
Discounting usually leaves the lender exposed to risk, as they are reliant on you being able to recoup customer payment and passing it on to them.
To reduce the risk, some lenders may insist on disclosed invoice discounting. It works like undisclosed discounting, except the lender is disclosed and the customer pays the lender rather than you. You will disclose the lenders name on your invoices and still be responsible for chasing debt.
A disclosed facility will be more expensive than an undisclosed one, but it is more accessible for higher-risk businesses who may struggle to get a favourable arrangement otherwise.
Who is eligible?
Invoice finance is a highly accessible option. All you need is B2B invoices as security, so you must be a business that sells to other companies.
Using an invoice facility on single, selected or across all your invoices are options. If your facility if across all your invoices, you may be able to negotiate more favourable rates.
Invoice finance is a great cashflow tool for many businesses, from start-ups to more established companies. It’s also ideal for growing SMEs, as the facility will expand as your business does.
Advantages
There are many benefits to utilising invoice finance. We’ve listed the five most prominent.
It’s accessible
The only security you require for invoice finance is unpaid invoices, so it’s a highly accessible solution. You do not need to use other assets as collateral, although you will have to sign a personal guarantee for typically between 10-20% of the facility, although this is negotiable. Almost anyone can apply for funding, provided they send out B2B invoices.
The variety of options available allows you to find an arrangement that suits your needs. Invoice factoring, for example, is open to low-turnover companies as the lender has more control and will be more willing to accept higher-risk businesses.
It’s cost-effective
An invoice finance facility is a relatively cheap form of external finance, more so than an overdraft. Although some costs are associated, these tend to be relatively low, and the interest charged is competitive.
Specific options will cost less than others (e.g. invoice discounting over factoring). However, both are still cost-effective. It’s imperative to compare different lenders to find the best deal for your needs.
It boosts cash flow
The primary advantage of invoice finance is that it boosts cash flow. It is a lifeline if you are facing short-term funding gaps or need support to manage cash flow.
If late customer payment has the power to impact your business cash flow, invoice finance is valuable in mitigating the effects and allowing you to survive without any disruption.
It even reduces the risk of bringing new customers on board as you have an option to retrieve capital, even if they are late in paying.
It releases capital quickly
As mentioned, funding may be released in 24 hours under an invoice finance facility. You only need to wait a short time to obtain the capital and inject it into your operations.
It is a solution if you already face cash flow struggles and need quick support.
It grows with your business
Finally, invoice finance is an ideal growth solution. By freeing up capital in your business, you will have the money you need to pursue growth. The funds may be used anywhere, including staff, training, supplies and premises often associated with expansion.
You will serve more customers and send out more invoices as you scale. These will allow you to raise greater sums to drawdown and continue to manage cash flow as you grow.
One in four owners also say invoice finance prevents time wasted chasing payment, allowing them to focus on expansion instead. In this sense, invoice finance allows for more time and capital to realise your growth goals.
Things to bear in mind
Although invoice finance offers many rewards, there are essential considerations you should make before committing. This will allow you to ensure it’s right for your business needs.
There are costs involved
Although invoice finance is affordable, there are associated costs. These tend to be focused on the administrative side of the loan, including service charges, trust, CHAPs and BACs fees. Factoring typically is more expenses than discounting.
Remember to check you understand the fee structures before committing and build this into your overall affordability considerations.
Select a type that suits you
We’ve already outlined the various types of invoice finance. You need to decide which one suits your business the most.
There are many factors to consider in coming to your decision. Firstly, you need to identify what is available in the market. If you have a low turnover or are a perceived risk, you might only be able to get a factoring agreement.
It’s also crucial to review your needs and ask which fits best, including:
- Are you willing to disclose to your customers that you’re using a lender?
- Do you want to maintain control of your customer relationships?
- Are you happy chasing customer payments?
Answering these should enable you to pinpoint the perfect solution.
Find a deal with competitive rates
Once you have understood which option you want to pursue, you need to find a lender to work with. It is worth comparing lenders as they each offer different terms and interest rates.
Working with a finance specialist is useful as they connect you with appropriate contacts and help you negotiate better rates.
How to access invoice finance
If you’ve decided your business could benefit from invoice finance, the first step to accessing it is finding a lender that suits your needs, whether a factoring or discounting arrangement. You then negotiate favourable terms that meet your needs and eligibility criteria.
Being a financial specialist, Pegasus Funding will guide you through the process. Our experts will explain invoice finance’s ins and outs, helping you identify a solutions that aligns with your needs.
We will connect you with relevant lenders from our extensive finance network.