Invoice Finance, Factoring and Discounting Explained

Invoice finance describes a range of invoice-based lending facilities, which allow your business to sell your invoices to a third party in exchange for a percentage of their value, thus preventing the adverse effects that slow and late payments can have on your cash flow. In this guide, we explain what invoice finance is, how it works, and what different types of agreement may be available to you.

What is invoice finance?

Invoice finance is a form of borrowing based on what your clients and customers owe to you in the form of unpaid invoices. As customers may have up to 90 days or more to pay their debts to your business, this type of financing allows you to unlock cash from these invoices. In simple terms, you ‘sell’ your unpaid invoice at a discount, receiving the remaining balance after payment.

With invoice finance, some of these funds become available as soon as invoices are raised, solving short term cash flow concerns. You can use the funds raised from invoice financing for a variety of purposes, from paying employees and suppliers to funding business growth initiatives. In this way, it can be seen as an alternative method of business funding compared to more traditional business loans and overdrafts.

How does invoice financing work?

The way invoice finance works depends on the type of agreement, but in general it will involve the following process:

  • You invoice your clients and customers as normal and pass the invoice details to your invoice finance provider
  • Your provider pays you a percentage of the invoice
  • Depending on the agreement, you will either chase the payment as normal (if necessary) or your provider fulfills this credit control function
  • Once the invoice is paid, you will receive the remainder of the invoice amount, minus any service charges

There are numerous benefits of invoice finance. Firstly, there are few restrictions in terms of sector and business size, meaning that it can be used for short term cash flow needs all the way through to funding substantial growth projects. Secondly, an invoice finance facility can be set up relatively quickly, meaning that it provides quick funding. Finally, it can act as a safety net, allowing you to manage your cash flow much more easily and efficiently.

Types of invoice finance: Invoice discounting vs factoring

Invoice finance is a collective term for a number of different invoice-based funding solutions, such as invoice factoring and invoice discounting. The key difference between these types of finance are around credit control, and who is responsible for chasing late payments.

Invoice factoring

As with any invoice solution, factoring involves a third party buying an invoice from your business. With invoice factoring, however, your invoice finance provider provides credit control services. When the invoice is due for payment, the lender is responsible for collecting payment from your customers; they will have direct contact with them so that they can ensure that payments are received promptly.

This may be the ideal solution for you, as it will free up time to focus on other matters rather than chasing late-paying customers. As well as collecting payments, your finance provider will cover other credit control functions, such as credit checking potential customers for you, issuing statements, collection letters and, if needed, legal action.

Invoice discounting

In contrast to factoring, with invoice discounting you will still have to manage your own credit control processes. While this means that you will remain responsible for chasing payments, it does have the benefit of keeping your invoice finance facility confidential.

Invoice discounting is ideal for businesses with established sales processing systems and who wish to use their own credit control team. Due to this, it is generally a better option for more established, high turnover businesses, while small and startup companies might find factoring a better solution.

Are there any risks associated with invoice finance?

We’ve already covered some of the advantages of invoice finance, primarily having access to the majority of an invoice within a matter of days and not having to take on extra liabilities or debt. However, there are some key things to consider when choosing an invoice finance solution.

Firstly, you may be concerned with potential damage to customer relationships if a third party manages credit control on your behalf. In this case, discounting would be preferable to factoring.

Secondly, you may have a legitimate concern with customers becoming insolvent and therefore being unable to pay their invoices. While ensuring that credit checks are made beforehand helps lower the risk of this kind of bad debt, it can also be mitigated by taking out bad debt protection as part of your invoice finance agreement. This works as a form of insurance that means that you’ll get paid even if customers become insolvent.

Finally, you may not want to put your entire ledger through the invoice finance facility, instead preferring to just finance a small number of invoices. In this case, single invoice finance would be a good option, particularly if you’re looking for a one-off cash injection.

White Oak offer SMEs the full range of business funding products, including asset finance, asset based lending, invoice finance, and business loans. We’ve cut the red tape from our business to offer quick, simple and straightforward finance solutions, so you can work more efficiently and effectively. Talk to us today on 0372 291 2766 to discuss your invoice finance options.