What is an Invoice Finance?

Invoice finance is a type of business financing where companies use their unpaid invoices to unlock cash flow. Essentially, businesses sell their outstanding invoices to a lender (a bank or a specialized finance company), allowing them to receive a portion of the invoice's value upfront, rather than waiting for the customer to pay. Once the customer pays the invoice, the remaining balance (minus fees) is released to the business.

This form of finance is beneficial for companies that have long payment terms with customers but need immediate cash for day-to-day operations, growth, or managing cash flow gaps. There are many types of invoice finance solutions, and it is important to learn if they fit your business before applying. 

Types of Invoice Finance

There are several main types of invoice finance, each with its benefits and structures:

1. Invoice Factoring

In invoice factoring, a business sells its unpaid invoices to a finance company (factor) at a discount. The factor advances a percentage of the invoice value (usually 70-90%) to the business and collects payment from the customer. Once the customer pays, the factor releases the remaining balance, minus fees.

Key Points:

The factor manages collections and credit control.

It's suited for businesses looking to outsource invoice management.

Eligibility Criteria:

Financial institutions are different and their requirements are also different. As standard eligibility criteria:

Your business must issue invoices for goods and services sold.

Your business must trade with other businesses and have several customers

Must offer credit terms that meet industry standards (30, 60 or 90 days).

You must prove that debts can be collected within a timescale

Must have a minimum  turnover generally between £50,000 and £100,000

Some institutions will require a minimum or maximum number of invoices a month

2.      Invoice Discounting

Invoice discounting is similar to factoring, but the business retains control of the customer relationship and collections. The finance company advances a percentage of the unpaid invoice value, but the business is responsible for ensuring the customer pays the invoice.

Key Points:

The customer typically isn’t aware of the arrangement.

It’s more suitable for larger businesses with established credit control processes.

3. Selective Invoice Finance

With selective invoice finance, businesses choose specific invoices to sell to the finance company, rather than all outstanding invoices. This offers more flexibility as companies can finance only the invoices they need to.

Key Points:

More control and flexibility over which invoices are financed.

Suitable for businesses with irregular cash flow needs.

4. Spot Factoring

Spot factoring is a type of selective invoice finance where businesses can sell individual invoices as needed. It’s on a case-by-case basis, offering maximum flexibility compared to regular factoring. The business will agree on rates and fees with a spot factoring company and then decide which invoice to assign to them. The spot factoring company will verify the invoice and advance a proportion of its value, usually around 70-85%, to the business.

Key Points:

Ideal for businesses that occasionally need quick cash.

Higher fees compared to regular factoring due to its flexibility.

Spot factoring company will chase the invoice from the clients and, once paid, will reimburse the business with the outstanding balance minus the agreed fees

5. Asset-Based Lending (ABL) with Invoice Financing

ABL is a more comprehensive financing solution where the lender provides a loan secured by various business assets, including invoices. This is often bundled with financing against inventory, equipment, and real estate.

Key Points:

ABL is suited for larger businesses with multiple assets.

The loan size depends on the value of the business’s assets.

Benefits of Invoice Finance

• Improved cash flow: Businesses receive quick access to cash tied up in unpaid invoices.
• Flexibility: Various options allow businesses to choose the right solution based on their needs.
• No additional debt: Unlike traditional loans, invoice finance is based on outstanding invoices, so it doesn’t add debt to the business's balance sheet.

Drawbacks of Invoice Finance

• Fees: Invoice finance involves service fees, which can reduce the overall amount the business receives.
• Customer relationships: In the case of factoring, the factor takes over collections, which could affect customer relationships.
• Eligibility: Not all businesses may be eligible for invoice financing, especially if they deal with slow-paying or unreliable customers.

Invoice finance can be a valuable tool for businesses looking to maintain liquidity while waiting for customers to pay their invoices. The best type of invoice finance depends on the company's size, needs, and preferences for managing customer relationships.