Invoice Factoring Explained

Invoice Factoring Explained

Invoice Factoring is a finance service whereby a Company uses the power of its unpaid invoices as collateral to borrow cash before their customers actually pay.

Bridging the Cashflow Gap Between Delivery of Your Service/Product and Your Customer Paying You

No matter what the size of a business, managing cashflow is key to it’s survival.  Businesses of all types will often experience the pain of having to deliver a product or service, upon which they can invoice their customer and then have to wait for payment to realise the cash and profit of the sale.

Invoice Factoring tackles exactly this problem.

Immediate Cash 

When you choose to use Invoice Factoring, in effect you are agreeing to ‘sell’ your customer invoices onto a Third Party (a Bank or Financial Institution).

In return for selling these invoices, your business will be given an amount, which depending on the provider can be up to 95% of their total value immediately (less any charges and interest).  

The third party will then take responsibility for chasing these debts which includes asking your customer to pay them instead of you.

You will probably be asked to include their bank details on your customer invoice rather than your own.  

Upon payment by your customer the remaining amount on the invoice.

In this example, 5% will be sent to you, again less any further interest or charges in accordance with your specific agreement.

Stabilising Cashflow

Using Invoice Factoring means your businesses cash flow can be predicted with much more certainty, allowing you to not only stabilise cashflow but also set growth plans in place.

In this ever-changing world, whereas invoice factoring used to be reserved for larger business, it is now a flexible form a finance available to SMEs and Start-Ups.

It can be a great option because you can simply use the facility as and when you make a sale.

Although there may be charges to set up the facility depending on the provider you go to.

Types of Businesses Suited to Invoice Factoring

Invoice Factoring is an ideal solution for Companies which are UK based, provide goods/services to another UK based Company and wait 30-90 days for customer payments.  Invoice Factoring is popular amongst the following types of businesses:

  • Temporary Recruitment
  • Clothing
  • Manufacturing
  • Logistics
  • Construction
  • Printing
  • Professional Services

The Fees and Charges

Typically there may be some kind of set up charge and the financier can request you bear the cost of some insurance charges (in the event your customer debt goes bad).

There will be a Factor Fee (anything like 2.5%), which covers the cost of chasing debts and providing you with a service and is based on the value of invoice you sell to the financier.  

A Discount Fee, which is an interest charge for the time between you are initially advanced money on your customer invoice and them settling the invoice, this can be anything like up to 3% over base rate.

Finally, there may also be a Management Fee, which is a monthly charge for having the facility in place.

Each bank and financier will vary in their charges.

That means it is really important to shop around and understand the true cost of using the Invoice Factoring Facility and you feel confident in the people you choose to work with.

After all they will be getting in touch with your customers to chase debts.

Invoice Discounting as an alternative

Customer and client relationships need to be carefully managed, especially if you are a growing business and are keen to open up your account further.  

A third party chasing your debts, potentially aggressively, may worry you.  

So if this is the case, Invoice Discounting may be the alternative option you are searching for.  

Invoice discounting operates in much the same way to Invoice Factoring, however, you continue to take responsibility for chasing your debts.

Depending on your size and staff availability, you may want to opt to use Invoice Discounting.

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.