Invoice financing is type of money advance on an unpaid invoice where there is a long payment date such as 60, 90 or 120 days. Businesses that are small and large can use invoice finance from companies such as Funding Invoice in order to better manage their cashflow – allowing them to receive money upfront which can be used towards their everyday costs and generating profit such as materials, staff, stock, equipment and more.
There are a few different types of invoice finance, although the differences to tend to be rather small. The two types we are going to be discussing in this guide are invoice factoring and invoice discounting.
Invoice factoring refers to a business applying for a third-party financier to borrow against for their invoices. The business will essentially sell their accounts receivable in return for cash from the third-party lender.
Accordingly, businesses will sell an entire sales ledger to an invoice company so that all invoices will go directly through the financier such as Funding Invoice. This finance company will then be responsible for following up on all payments from businesses and any outstanding debts, otherwise known as credit control. It is essentially like handing over your entire list of outstanding invoices.
In the case of invoice factoring, the value of the assets needs to be significantly for finance firms to take on entire ledgers. They need peace of mind that the debtors are good, strong, reliable companies and likely to pay as per their agreements. The finance house will typically add interest on the value of the interest, with the longer the payment terms, the more interest that accrues.
Companies that typically use invoice financing include those that receive large orders or need work in capital in order to fulfil their obligation i.e staff, materials. Hence invoice factoring is commonly used by:
- fashion designers and startups
- construction and building companies
- caterers and food businesses
- fast moving consumer products e.g electronics, food, lifestyle products
Invoice discounting is very similar in the fact that you receive money upfront for your invoices and this is typically 70%, 80%, 90% of the total invoice amount.
The difference is that you as the company continue to manage your credit control and the business partner who eventually pays after 60,90 or 120 days will pay you directly. You just need to pay the interest or service charge to the lender that you work with who has given you the cash advance.
When using invoice financing, the debtors know of your arrangement with an invoice finance company because they are managing your credit control. But with invoice discounting, there is a bit more privacy because the customer is dealing with their partners directly.
It is also known as invoice trading because you are using invoice loans as a pay-as-you-go kind of method and you are not putting all your invoices with one invoice finance firm.
Which businesses are they suitable for?
Any business which regularly invoices customers will see a benefit from invoice financing or discounting, particularly when there are long payment terms which is very common from large supermarkets and retailers. Those companies who receive big orders and the need the money to process it, will benefit from an invoice advance, hence it is popular for caterers for weddings, fashion designers and people selling thousands of products.
The invoice is verified by the finance provider with the payer and then this is used as a security for a loan. By having the invoice sent to a large company such as Tesco, ASOS or Amazon, certainly strengthens your case since they are established and likely to pay.
However, those businesses which are smaller and have much more limited funds, less resources and time are more much better off using the factoring method.
This is due to being far more likely to be accepted for factoring over discounting, since invoice discounting companies often only accept companies who can show they have high turnovers (which is usually classed as £100,000 or over).
Since invoice discounting does not give credit control to the lender, they may favour factoring for smaller businesses. This will give the lender a far greater feeling of security and peace of mind.
If you are not sure which is right for you, read our guide on finding the right type of finance for your business.