Invoice financing is a process where a third party decides to buy your unpaid invoices. Invoice financiers may be from a financial institution or a bank or work independently.
There are two types of invoice financing in the United Kingdom.
‘Debt factoring’ or invoice factoring usually involves an invoice financier that manages your sales ledger and collects money owed by your clients themselves. This will also mean that your customers will know that you are using invoice finance.
1. When you raise your invoice, the invoice financier will purchase the debt owed to you by your client.
2. They’ll make a percentage of the cost (around 85%) available to you upfront.
3. They then get the full amount directly from the customer.
4. Once they’ve obtained the money from your customer, they will then make the outstanding balance available to you.
5. You’ll have to pay the financier a discount charge (interest) and other fees; this amount depends on the invoice financier that you use.
Your customer owes you £40,000. You sell your invoice for £34,000 (85%) to an invoice financier. They collect £40,000 from your client and give you the remaining £6,000 when they get the money. You pay them any fees and interest and that you owe.
With ‘invoice discounting’, the invoice financier will not collect debts for you or manage your sales ledge. Instead, they lend you money against your unpaid invoices in an agreed percentage of their total value. You’ll then have to give them payment.
As your clients pay their invoices, the payment goes to the invoice financier. This will reduce the amount you owe, which enables you to borrow more money on invoices from the latest sales up to the originally agreed upon percentage.
You will still be responsible for collecting debts if you’re using invoice discounting; you can also have it confidentially arranged so your customers will not find it out.
Both kinds of invoice financing can give your cash flow a quick and large boost.
Factoring’s advantages include:
* the invoice financier will take care of your sales ledger which can free your time to manage your business
* they credit check potential customers so you’re likely to work with customers that pay on time
* they can help negotiate better terms with suppliers
Invoice discounting’s advantages include:
* it can be confidentially arranged so your customers won’t know that you are borrowing against their invoices
* it helps you maintain closer relationships with customers since you’re still managing their accounts
Invoice financing’s disadvantages are:
* you’ll lose profit from your orders or services
* invoice financiers usually buy commercial invoices only – you might not be eligible if you sell to the public
* it may affect how you can get other funding since you won’t have available ‘book debts’ for security
If you’ll use factoring:
* your clients may prefer directly dealing with you
* it may affect what your clients think of you if your invoice financier badly deals with them