With the help of invoice finance, companies can sell their outstanding receivables to a lender so that they receive cash quickly. This is particularly useful if the amounts owed are very high or if a company grants its customers very long payment periods. We show you here what types of invoice financing there are and how it works exactly.
Invoice finance: Meaning
Invoice finance is when a lender buys an unpaid invoice from a seller. The seller then receives a partial amount of the invoice immediately, regardless of how long the payment period of the invoice is.
Companies often make use of invoice financing when they need to get cash quickly. They then sell their outstanding receivables to a factoring provider. The provider pays the invoice immediately and retains a portion of it as a fee for itself.
Types of invoice financing
With factoring, an amount of 80% to 90% of the outstanding receivable is usually paid out immediately to the seller. Factoring providers often also take over the collection of payments from their customers for their sellers.
The principle of invoice discounting is the same as that of factoring: the lender pays out a certain amount of the outstanding receivable immediately. The only difference is that the seller himself takes care of collecting the payments from his customers. He then pays the amount plus a fee back to the lender when the payment is received.
Invoice finance costs
The fees for invoice financing vary depending on the conditions of the provider and the type of financing. Often a fee of 10% of the invoice amount is due. In addition, some providers also charge a service fee ranging from 1% to 3% of the invoice amount.
Invoice finance is therefore usually only worthwhile for very large amounts of receivables, or if a company needs to get cash very quickly, for example because a cash shortage is imminent.
Single invoice finance & contracts
Invoice financing providers often offer different services depending on what clients need. Some providers enter into contracts with their clients in which they agree to sell all receivables to the provider for a certain period of time.
Other providers offer the option of single invoice financing, for example if a company only needs an advance for one invoice. These offers are usually more expensive than long-term contracts, but they do not bind a company to the invoice finance provider for a long time.
Invoice finance: Example
A company sends a customer an invoice for £20,000. The customer has 90 days to pay the invoice. However, the company needs cash quickly to make an investment. As the company has contracted with a factoring provider, the provider pays 80% of the invoice amount immediately, i.e. £16,000.
The company's customer pays its invoice in full 90 days later. The factoring provider, who also takes care of the company's payments, thus gets back the borrowed sum of £16,000. He charges 10% of the amount owed, i.e. £2,000, so the business still receives £2,000 (£20,000 - £16,000 - £2,000).
Invoice finance for small business: Is it worth it?
As mentioned above, invoice financing is usually only worthwhile for very high amounts of receivables. However, this does not mean that this form of financing is out of the question for a small business. Rather, it depends on how high the average amount of receivables is in a year and how long the payment terms are that the company grants its customers.
It can also make sense for a small business to use invoice finance if the payment terms for its invoices are very long (e.g. 60 days or longer). This helps to maintain cash flow so that the business can continue to invest and pay its own bills.
Choose invoice finance facility with care
Some invoice finance providers only offer their services to companies that have a certain minimum annual turnover and only to B2B customers. It is advisable to compare offers from different providers as invoice finance is not regulated in the UK.
Providers are therefore sometimes intransparent when charging fees, which can lead to unpleasant surprises. We advise you to read the conditions carefully and also to calculate whether this type of financing is worthwhile for your company.
Benefits of invoice finance
The biggest advantage of invoice finance is that it improves a company's cash flow. This is particularly noticeable when the payment terms of the receivables are very long.
Because the company immediately receives a certain amount of cash from the lender, it remains liquid.
Invoice financing can also be scaled well. If the company grows and its stock of accounts receivable grows, the lender simply pays out a higher amount. Depending on the contract, the lender also takes care of collecting payments so that the company can outsource its entire receivables management.
Drawbacks of invoice finance
The biggest disadvantage of invoice finance is that it is a very expensive way of financing. Providers charge fees proportionate to the amount of the receivable, which can be 10% or more. This means that a company loses a large proportion of its profit.
A company that has mainly private customers and no business customers cannot usually make use of invoice finance, as factoring providers often only offer their services to companies in the B2B sector.