Managing cash flow is a continuous problem for so many businesses (and not just the small ones). There is a constant juggle to keep paying salaries, services, and the day-to-day running costs. Thankfully, there are also solutions. Invoice factoring, one form of invoice finance, is here to help.

Invoice Factoring in Four Quick Points

Just want to know the main points? Here’s the low-down:

Invoice factoring is a form of short-term invoice finance to release money from an unpaid invoice without having to wait for the customer to pay.
It effectively entails selling the outstanding customer debt to a factoring company.
It can be helpful with unreliable customers and those on long payment terms.
It can also be set up as a line of credit for ongoing benefits, allowing you to “dip in” to its services when you need to.

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What is Invoice Finance?

Invoice finance is a type of business loan that covers a range of ways to borrow money using your outstanding invoices as a guarantee. It enables businesses to free up cash a little earlier than the invoice payment date, cutting down on that difficult time between an invoice being issued and it being paid.

While there are a few different types of invoice finance, for most businesses, it is invoice factoring that provides the best option.

What is Invoice Factoring and How Does It Work?

Invoice factoring involves a lender - the “factoring company” - purchasing the debt of your outstanding invoice from you, which provides you with a substantial portion of your outstanding invoice value as soon as you need it.

When the invoice is finally paid by your customer, it is paid to the factoring company who then pay the remainder of the invoice to you, minus their fee.

In short - your business gets paid early in exchange for a percentage fee of the total invoice.

How Much Can I Get with Invoice Factoring?

It’s possible to borrow up to the value of 90% of your outstanding invoices with invoice factoring.

The exact amount will depend on various factors including:

Your business sector

Your invoice terms
Customer reliability
Your business credit score

The factoring company will also impose a credit limit which is, in essence, the total sum you can borrow against the invoices. This will depend on your business size and turnover.

Invoice factoring can cover amounts from £1,000 through to £5 million for large businesses.

Is Invoice Factoring a One-Off Loan?

Invoice factoring can be used as one-off loan against a single invoice or as a continuous line of credit service for your business.

The latter can allow you to maintain cash flow for many months or even years.

How you use invoice factoring is generally determined by the needs of your company.

What Does Invoice Factoring Cost?

Invoice factoring generally incurs the following costs:

Discount charge (ranging from 0.5%-7%)
Service fee (generally 0.75%-2.5% of your business turnover)
Credit protection chargers (generally 0.75-2.5% of turnover)

Here’s a more detailed breakdown:

The Discount Charge

This is effectively the interest on your loan. It is calculated based on the invoice value and will be applied as a weekly or monthly fee.

Discount charges will range from 0.5% to 7% depending on a number of factors, one of which is the size of the invoice.

Typically, a larger invoice will come with a smaller discount charge, so it is usually best to obtain invoice factoring against your larger invoices rather than smaller ones.

The interest rate is also heavily influenced by the BoE base rate, and rates will usually hover roughly 2-3% above it.

The Service Fee

This is an administrative monthly fee applied by the factoring company for their services. As they become responsible for following up and collecting the outstanding debts, the service fee will reflect that.

Service fees for factoring are based on your business turnover and are generally between 0.75% and 2.5% of that figure.

Credit Protection Charges

Factoring companies take on the risk of any bad debts from your unreliable customers and will apply a credit protection charge based on their assessment of this risk.

This additional fee may be from 0.5% to 2% of your turnover.

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Understanding the Total Cost of Factoring

The greatest impact on factoring is the time it takes for your customer to pay the outstanding invoices.

With the fees incurred monthly, delays by your end customer will result in higher charges.

So, while it may be beneficial to use invoice factoring to clear the outstanding balances from customers with longer invoicing terms, and those who are less reliable with their payments, ultimately the return you will get from these invoices will be more diminished than those that pay on time.

Watch our short video below to learn about invoice finance in more detail.

Can Anyone Get Invoice Factoring?

Invoice factoring is available to all types of business, though many factoring companies offer their services to limited companies only.

Clifton Private Finance are here to help you get the invoice factoring you need, with experts able to help both self-employed companies and partnerships, as well as limited companies and enterprises of all sizes.

The Pros and Cons of Invoice Factoring

Invoice factoring is a great option for many companies, but like all types of business finance, it does have its plus points and negatives.

The main pros and cons of invoice factoring include the following:

+ Bridging the Gap

The main advantage of invoice factoring is in its suitability to help bridge the gap between an invoice being issued and the cash being available.

This is especially useful for business that are trying to grow by taking on larger clients.

Often, a larger business will feel able to dictate the payment terms on invoices, which the smaller provider willfeel obliged to accept.

Through invoice factoring, money that is tied up with unfavourable 90-day terms can be released.

- Souring Relationships

Probably the biggest downside to invoice factoring is the potential negative impact it may have in your relationship with your client.

As the debt is sold to the factoring company and administered by them going forward, the end customer will be made aware that factoring is taking place and may react negatively to the idea that they are “not trusted” to pay their invoice on time.

+ Dealing with Bad Debt

The factoring company takes on all the risk factors with your outstanding invoice, which includes being responsible for chasing any dues from unreliable customers.

These bad debts can require specialised administration that your business simply cannot handle; by passing them on to an experienced factoring company, the associated problems of debt recovery no longer remain yours to deal with.

- Costs

As with all lending, invoice factoring is not without its costs.

Once invoice factoring is used, the profit made by your work and services will diminish. In situations with low margins, it could feel as if the work was hardly worth doing in the first place.

+ An Extra Line of Credit

An ongoing invoice factoring contract represents an additional line of credit for your business that can be called upon when needed, to help cash flow throughout your business life.

- Credit Reliance

Becoming reliant on invoice factoring will incur additional costs for your business and lower the value of your invoices, potentially harming your long-term growth and profitability. As with all types of business loans, it should be managed well to avoid unnecessary expenses.

Alternatives to Invoice Factoring

There are several alternatives to invoice factoring to help you with ongoing cash flow and delays with invoice payments. These include:

Invoice Discounting

Another type of invoice finance, invoice discounting is a secured loan that utilises your outstanding invoices as collateral. It is an alternative to invoice factoring that leaves you in control of the customer account and thus remains invisible to the customer.

Alternative Lines of Credit

Short term credit solutions such as overdrafts and credit cards can often be used in place of invoice factoring. If well managed, these other lines of credit can be less expensive than invoice factoring, though a reliance on them can be considerably more costly.

Other Short Term Loans

Other solutions such as unsecured business loans or asset financing could offer similar help with cash flow. Depending on the products, it may be possible to get a short-term loan that is more favourable for your business.

Merchant Cash Advance

Invoice factoring is designed for business-to-business (B2B) companies. If you deal direct to the customer (B2C) using frequent and multiple card transactions, then a merchant cash advance could offer a better solution.

Holding the Line

One final option is to simply grit your teeth and hang in there! If you are confident that your customer will pay the invoice once the terms come around, then it may be best to just tighten your belt until they do.

Consider discussing payment terms with trusted and reliable clients or perhaps shortening your invoice terms to better help your cash flow.