Invoice finance is booming. Several factors explain this success. Over the past two decades, some key events have changed the way small and medium businesses borrow. The 2008 financial crisis had a lasting impact on the functioning of companies. Meanwhile, the uncertainty surrounding Brexit has reduced traditional borrowing in the UK. Finally, in 2020, the pandemic wreaked havoc on the economy.
Traditional loans are more difficult to access for small businesses and those that have been established recently for quite some time. During the pandemic, bill payments are slowed down. This has further increased the intense pressure exerted on SMEs which must continue to pay salaries and suppliers. Business leaders therefore need a simple, accessible and economical way to maintain their cash flow. All lenders base the cost of borrowing on risk. However, freeing the cash from unpaid invoices represents relatively low risk taking.
What is invoice finance, and how does it work?
Invoice finance is a quick and easy way to borrow funds that are secured against the value of your unpaid bills. When you issue an invoice, a lender advances a percentage of the billed amount to your business (usually around 90%) - and some providers guarantee payment within twenty-four hours.
Depending on the type of invoice financing you are requesting, a credit check will be performed by the lender or by you. In this case you receive the remainder of the invoice value, minus the finance charge when it is paid by your customer.
Invoice discounting versus invoice factoring
The two primary types of invoice finance are invoice discounting and invoice factoring. The difference between these two financings is the person responsible for collecting payments. For businesses, there are two main factors to consider when choosing one of the two solutions. The two questions to ask yourself are therefore whether you are willing to let your customers know that you are using invoice financing and whether you want to outsource credit checking.
Discounting invoices is the easiest solution. You borrow against the value of the invoice while maintaining control over the continuation of payment.
With invoice factoring, the finance company performs the credit check. Your customers will know that you have outsourced the operation.
Invoice financing is available for almost any SME, from established businesses to startups and new businesses, but invoices are best matched to B2B sales.
How much does invoice financing cost?
It depends on the choice of factoring or discounting. Invoice factoring costs tend to be higher because the credit check is handled by the lender.
The usual charge for financing invoices is between 0.5% and 5% of the invoice value. However, not only your credit rating but also other factors can influence this rate. The amount of the invoice that you want to finance can also have an impact on the charges. Higher amounts tend to attract lower fees than for lower value bills.
How can invoice financing help my business?
The popularity of invoice financing is because it is a relatively healthy way to maintain a healthy cash flow. However, it is advisable to use it as part of your broader cash flow forecasting and planning. It is dangerous to depend on any form of funding. Nonetheless, as a supplement during times of low working capital, invoice financing can be a cost effective solution to allow you to pay your expenses, salaries, suppliers and even retail property rents.
Who regulates invoice finance in the UK?
The FCA (Financial Conduct Authority) doesn’t regulate invoice financing, but UK Finance does have a code of conduct for providers in the space. As with all financing, it is best to seek advice from your finance or accountant before resorting to it.