Quick Definition: Invoice factoring is a financial service where UK businesses sell their unpaid invoices to a factoring company for immediate cash, typically receiving 70-90% of the invoice value within 24 hours. The factoring company then collects payment directly from your customers.
Last Updated: July 2025 | Reading Time: 8 minutes | Author: Phillip Evans
Running a business means waiting for customers to pay their bills. This waiting game can hurt your cash flow badly. Invoice factoring offers a smart solution to this common problem.
Key Statistics:
Invoice Factoring Definition: A financial arrangement where businesses sell their accounts receivable (unpaid invoices) to a third-party factoring company in exchange for immediate cash flow, typically receiving 70-90% of the invoice value upfront.
Invoice factoring is a financial service that helps businesses get paid faster. You sell your unpaid invoices to a factoring company. They give you most of the money straight away.
The factoring company then collects payment from your customers. When your customers pay, the factoring company keeps a small fee. They send you the remaining balance.
This process turns your unpaid invoices into immediate cash. You don't need to wait 30, 60, or 90 days for payment anymore.
Real Example: Sarah runs a marketing agency in Manchester. She invoices £10,000 to a client with 60-day payment terms. Instead of waiting, she factors the invoice. Within 24 hours, she receives £8,500 (85% advance). When the client pays after 60 days, Sarah gets the remaining £1,000 minus a £500 factoring fee.
The invoice factoring process follows these simple steps:
Most factoring companies advance between 70% and 90% of your invoice value. The exact percentage depends on your industry and customer credit ratings.
With recourse factoring, you keep the risk if customers don't pay. If a customer fails to pay, you must buy back the invoice. This option costs less because you take on more risk.
Recourse factoring works well for businesses with reliable customers. It's the most common type of factoring in the UK.
Non-recourse factoring transfers the bad debt risk to the factoring company. If your customer doesn't pay, the factoring company takes the loss. This protection costs more but gives you peace of mind.
This option suits businesses dealing with new or risky customers. It protects your cash flow from customer defaults.
Spot factoring lets you factor individual invoices as needed. You don't need a long-term contract with the factoring company. This flexibility helps with occasional cash flow problems.
Small businesses often prefer spot factoring. It gives them control over which invoices to factor.
Whole turnover factoring requires you to factor all your invoices. You can't pick and choose which ones to include. This approach often gets you better rates and terms.
Larger businesses with steady invoice volumes benefit most from this option. It provides consistent cash flow improvement.
|
Finance Option |
Speed |
Cost |
Debt Created |
Credit Requirements |
|
Invoice Factoring |
24-48 hours |
1-5% per invoice |
No |
Based on customer credit |
|
Bank Loan |
2-8 weeks |
3-8% annually |
Yes |
Strict credit checks |
|
Overdraft |
Instant (if approved) |
15-25% annually |
Yes |
Good credit history |
|
Invoice Discounting |
24-48 hours |
2-4% annually |
No |
Strong credit rating |
|
Asset Finance |
1-2 weeks |
4-12% annually |
Yes |
Asset as security |
Invoice factoring solves cash flow problems quickly. You get money within 24 hours instead of waiting months. This speed helps you pay bills, wages, and suppliers on time.
Better cash flow also lets you take on more work. You can accept larger orders without worrying about payment delays.
Factoring doesn't create debt on your balance sheet. You're selling an asset (your invoice) rather than borrowing money. This keeps your debt-to-equity ratio healthy.
Banks view factoring differently from loans. It won't hurt your chances of getting other financing later.
Many factoring companies offer credit checks on your customers. They help you avoid customers with poor payment histories. This service protects you from bad debts.
Some factoring companies also provide debt collection services. They handle chasing overdue payments for you.
Steady cash flow helps your business grow faster. You can invest in new equipment, hire staff, or expand your premises. Growth becomes easier when money isn't tied up in unpaid invoices.
Factoring also frees up your time. You spend less time chasing payments and more time growing your business.
SMEs benefit most from invoice factoring. They often struggle with cash flow gaps between completing work and getting paid. Factoring bridges this gap effectively.
Many SMEs can't access traditional bank loans easily. Factoring provides an alternative funding source based on invoice quality, not just credit scores.
Business-to-business companies make ideal factoring clients. B2B invoices typically have longer payment terms than consumer sales. This creates bigger cash flow problems that factoring solves well.
B2B customers also tend to pay more reliably than consumers. This reliability makes factoring companies more willing to advance higher percentages.
Service businesses often have large gaps between providing services and receiving payment. Factoring helps consultants, agencies, and contractors smooth out these cash flow bumps.
Service invoices also tend to be disputed less than product invoices. This makes them attractive to factoring companies.
Factoring companies charge fees in two main ways:
Higher-risk invoices cost more to factor. Newer businesses also pay higher fees than established companies.
Cost Calculator Example:
Watch out for these extra costs:
Always ask for a complete fee breakdown before signing up. Hidden charges can make factoring much more expensive than expected.
|
Industry |
Average Factoring Fee |
Typical Advance Rate |
|
Professional Services |
2.5% |
87% |
|
Manufacturing |
3.2% |
82% |
|
Construction |
4.1% |
78% |
|
Recruitment |
2.8% |
85% |
|
IT Services |
2.3% |
89% |
|
Import/Export |
3.8% |
80% |
Tier 1 Providers (£1M+ turnover):
Specialist SME Providers:
Look for factoring companies with strong track records. Read online reviews and ask for customer references. Avoid companies with lots of complaints or legal problems.
Check if they're members of trade associations. The Asset Based Finance Association (ABFA) sets standards for UK factoring companies.
Red Flags to Avoid:
Different factoring companies offer varying terms:
Get quotes from several companies before deciding. Make sure you understand all terms and conditions fully.
You'll work closely with your factoring company. Choose one that responds quickly to questions and problems. Poor communication can damage relationships with your customers.
Ask about their customer portal and online systems. Modern technology makes factoring easier to manage on a day-to-day basis.
Questions to Ask Potential Providers:
Key Regulations:
Under UK law, you have specific rights when using factoring services:
Essential documents for factoring applications:
Financial Documents:
Legal Documents:
Many businesses focus only on advance rates and miss important contract terms. Always review:
The cheapest option isn't always the best. Consider:
Failing to explain factoring to customers can damage relationships. Best practices:
Even with factoring, maintaining good credit control practices is essential:
Business: Software development company, £2M annual turnover Challenge: 60-day payment terms causing cash flow gaps Solution: Whole turnover factoring at 85% advance rate Results:
Business: Engineering components manufacturer, £800K turnover Challenge: Large customer orders requiring material purchases upfront Solution: Selective invoice factoring for major orders Results:
Business: Digital marketing services, £500K turnover Challenge: Seasonal cash flow variations, unreliable payments Solution: Non-recourse factoring with credit protection Results:
Invoice discounting works similarly to factoring but with key differences. You keep control of your sales ledger and collect payments yourself. The finance company stays invisible to your customers.
This option costs less but requires more work from you. It suits businesses that want to maintain direct customer relationships.
Asset-based lending uses your invoices as collateral for a loan. You keep ownership of the invoices but get a credit line against their value.
This option provides more flexibility than factoring. However, it creates debt on your balance sheet and may require personal guarantees.
Traditional overdrafts can help with short-term cash flow problems. They're often cheaper than factoring for small amounts and brief periods.
However, banks are reducing overdraft facilities. They also require strong credit ratings and may demand security.
Invoice factoring works best when you have these characteristics:
Consider factoring if you're experiencing these problems:
Factoring companies will want to see:
Having this information ready speeds up the application process significantly.
Consider beginning with spot factoring or a small credit line. This lets you test how factoring works for your business without major commitments.
You can always increase your facility or switch to whole turnover factoring later. Starting small reduces risk while you learn the system.
Most factoring companies provide funds within 24 hours of approving your invoice. Some can even transfer money on the same day. This speed makes factoring ideal for urgent cash flow needs.
The approval process is usually faster than traditional loans. Factoring companies focus on your customer's creditworthiness rather than your business credit score.
Typically, you'll receive 70-90% of your invoice value immediately. The exact percentage depends on several factors:
Established businesses with high-quality customers often get advance rates of 85-90%.
This depends on the type of factoring you choose. With traditional factoring, your customers pay the factoring company directly. They'll know you're using the service.
With invoice discounting, the arrangement stays confidential. You continue collecting payments from customers yourself. The factoring company remains invisible to your clients.
The answer depends on whether you have recourse or non-recourse factoring:
Recourse factoring: You must buy back any unpaid invoices after an agreed period (usually 90-120 days). You keep the credit risk.
Non-recourse factoring: The factoring company takes the loss if customers don't pay. This protection costs more but gives you peace of mind.
Factoring fees typically range from 1-5% of your invoice value. The exact cost depends on:
Monthly fees may also apply, usually 1-3% per month until your customer pays. Always ask for a complete fee breakdown before signing up.
Most factoring companies prefer invoices from creditworthy business customers. They typically won't factor:
The factoring company will usually run credit checks on your customers before approving their invoices.
Most factoring companies set minimum invoice values between £500 and £1,000. Some specialist providers will factor smaller invoices, but fees may be higher.
There's usually no maximum limit, though very large invoices may require additional credit checks or approval processes.
Contract lengths vary widely:
Shorter contracts offer more flexibility but may cost more. Longer agreements typically provide better rates and terms.
Invoice factoring doesn't appear as debt on your balance sheet, so it shouldn't directly harm your credit rating. However:
Always maintain good relationships with your factoring provider to protect your credit standing.
Yes, but you'll need to discuss this with your factoring company first. Early payment discounts reduce the amount they collect, which affects their fees and your advance rate.
Some factoring companies will adjust their terms to accommodate discount policies. Others may prefer you avoid offering discounts to factored invoices.
Factoring works well for most B2B industries, particularly:
Service-based businesses often find factoring especially beneficial due to longer payment terms and reliable customer bases.
Switching factoring providers involves several steps:
Good planning ensures no disruption to your cash flow during the transition.
Business Characteristics:
Financial Situations:
Online Portals Features:
Artificial Intelligence Applications:
Emerging Trends:
Market Predictions:
If you're considering invoice factoring for your UK business:
Remember that factoring is just one tool in your financial toolkit. The best approach combines factoring with strong credit control, efficient operations, and strategic business planning.
Invoice factoring offers a practical solution to cash flow problems. It turns your unpaid invoices into immediate working capital. This improvement helps you grow your business faster and more confidently.
The key is choosing the right factoring company and terms for your situation. Take time to compare options and understand all costs involved.
Remember that factoring is a business tool, not a magic solution. It works best as part of a broader financial strategy. Use it wisely to support sustainable business growth and improved cash flow management.