Table of Contents
    Add a header to begin generating the table of contents

    When should a business owner consider invoice factoring as a viable funding solution?... Don't until you've read this article.

    When businesses sell products or services to customers, they may do so on credit. This is usually the case in the B2B space where suppliers or manufacturers sell to wholesalers or retailers. This means that the customer does not have to pay immediately for the goods or services they have purchased. 

    What follows is a process that every business owner will be familiar with: the party that is selling the product or service to the buyer will issue an invoice. This will detail the cost, relevant taxes, and the payment’s due date such as 30, 60 or days in the future. This is good for the customer, as it buys them time to make the payment. However, for the seller, providing goods or services on credit now has their money tied up which could be utilised elsewhere. 

    To take up the slack from slow-paying customers or to free up cash, businesses may choose invoice factoring. Invoice factoring is a short-term solution offered by banks and financial institutions to help businesses access working capital against the value of outstanding payments (debtors). With this improvement in cash flow, companies can work faster and focus on growth. 

    What is Invoice Factoring?

    Invoice factoring is a way for businesses to borrow money against the amounts due from their customers. With these short-term loans, businesses can improve cash flow to better manage expenses like salaries and supplier costs. Equally, they can also use the money to invest in operations and growth more efficiently than if they had to wait for their customers to pay off their balances. 

    Invoice factoring can offer a solution to problems associated with slow payments, bad credit, or difficulty obtaining other types of loans. 

    What makes invoice factoring distinct from other types of invoice financing is that it is a complete service where the lender manages your outstanding invoices and credit notes. First, they will assess the value of the outstanding invoices, or your sales ledger, and purchase the debt. They’ll then make the equivalent funds available to you, taking into account the relevant fees under the factoring agreement. 

    Invoice factoring is a disclosed service. This means that your customers are aware of the lender’s involvement and the lender will help you chase your debts. Under such agreements, the customer will not pay you directly, and instead, they will deal with the lender’s representatives. 

    For some businesses, this is an advantageous arrangement. The lender’s facilities will help you keep your accounts in order, relieving administrative pressure and giving you the time and capital to make strategic investments in your business. Equally, it can help you broker more favourable terms with your suppliers, as you will be able to pay faster. It also strengthens your position: with fewer cash flow problems, you are more organised, leaving yourself less open to risk if you include bad debt protection cover. 

    Most lenders will also offer an electronic platform, helping you keep track of your account. Another advantage, depending on the lender, is that invoice factoring can help you expand your business’s reach. Many global banking brands will have multi-lingual teams, so you can communicate with global clients with greater ease.

    How does factoring work?

    Invoice Factoring Under an invoice factoring agreement, the lender will buy a customer’s debts to your business, subject to exclusions, terms and conditions. They will then make a percentage of the value of this debt available to you. Usually, this will be between 80-95% of the invoice value. 

    Meanwhile, the lender will take control of your sales ledger. This means that they will deal with customers on your behalf, chasing invoices and managing payments. When the customer is ready to clear their balance, they will pay the lender via a bank “client account” setup in your Company Name allowing the lender to see which invoices have been settled.

    The lender will retain the remaining 5–20% until the customer clears their invoice. When the customer pays, the lender will then release the remainder of the funds, less their charges and fees for the use of their facility. Usually, the fee is between 0.75% – 3.45% of the total value of their invoices over a given period.

    Below is a basic example of factoring your debtors:

    Let’s say the total value of your sales ledger is £100,000. Your clients have 60 days to pay their invoices, so you could be waiting for up to two months for this cash. Under the invoice factoring agreement you have chosen, the lender will provide you with 90% of the value of the invoices in advance. This means you will receive £90,000, sometimes as fast as that same day. 

    When the client clears their invoice – let’s say in 60 days time – the lender will return the remaining 10% of the invoice value. However, they will deduct their fee for providing the facility. If the lender’s fee is 2%, they’ll take £2,000 and £8,000 will be returned to you. This will increase cash flow and can protect you from bad credit where you have pressure to pay creditors.

    What is the Difference Between Invoice Finance and Factoring?

    Another term you might have heard of is invoice finance, which is the umbrella term that describes financial services that make funds available against the value of a sales ledger. Invoice factoring is a subset of invoice finance, which in turn has subsets of its own. We will discuss these in more detail below. 

    However, at this stage, it’s useful to mention the other principal type of invoice finance: invoice discounting. Invoice discounting works similarly to factoring, but with an important difference. Invoice discounting is an undisclosed service, which means that you retain control of your sales ledger and you are responsible for liaising with clients. Customers are not usually aware of the lender’s involvement and will pay you directly, albeit into a designated account. 

    As with invoice factoring, the lender will purchase a percentage of the debt in your sales ledger. This cash will be made available to you fast and the difference minus fees will be credited once the customer pays their invoice. This is a good option for companies who want to maintain a close relationship with their clients. However, it’s useful to bear in mind that lenders like to see a healthier turnover to sign off on an invoice discounting agreement, which makes factoring a more accessible option.

    Different Types of Invoice Factoring Facilities.

    Now we have clarified the differences between invoice finance, factoring, and discounting, we will look in more detail at different invoice factoring options.

    Single Invoice Factoring or Spot Factoring

    Single invoice factoring or spot factoring is a targeted, ultra-short-term type of invoice factoring. Instead of financing your entire sales ledger on an ongoing basis, the lender will buy the debt on a single invoice. Generally, spot factoring is suitable for SMEs that have an established and trusted client base, with a low level of invoice disputes. 

    Typically, the factored invoice will be a large bill of over £25,000. It’s worth noting that spot factoring releases less money upfront than ongoing invoice factoring – usually, the initial funding available will be between 75-85%. Although it provides greater flexibility as you choose which invoices to finance, it’s still a disclosed service, so if you do factor an invoice it will then be down to the lender to chase the client.

    Recourse and Non-Recourse Invoice Factoring

    Occasionally, a customer might be a slow payer because they are experiencing financial difficulties. If you have an invoice factoring agreement in place and the customer goes bust, you’re faced with a problem: how will the lender be paid back the money they advanced to you? This is why some invoice factoring products will come with bad debt protection insurance. Known as non-recourse invoice factoring, this means that you are financially protected should a customer go bust. 

    The other option is recourse invoice factoring. This means that should a customer go bust and not pay their invoice, the responsibility to ensure the lender is paid back remains with you. This is a risk some companies are willing to take if they have a reliable, established client base, as generally, recourse invoice factoring has lower fees.

    CHOCS - Customer Handles Own Collections

    CHOCS, which stands for customer handles their own collections is an ideal factoring solution for business owners who already have their own credit control and collection staff in place. 

    Industry specific Programmes

    Some lenders will offer invoice factoring products tailored to the specific needs of certain sectors. Examples include:

    Recruitment Invoice Factoring

    Recruitment agencies often have a diverse customer base, with clients varying in size, sector, and the frequency that they will require the agency’s services. This means business for recruitment agencies is sporadic and cash flow isn’t always steady.

    Another obstacle is temporary recruitment, where candidates remain on the agency’s payroll while carrying out their work. This means recruitment agencies can find themselves in a tight spot if invoices are not cleared regularly.

    Recruitment invoice factoring bridges this gap and relieves the administrative burden, helping recruitment agencies balance seasonal fluctuations.

    Construction or Contractual Debt Invoice Factoring

    The construction industry faces unique challenges when it comes to cash flow. Often, small firms are strong-armed into unfavourable JCT or NEC contracts by bigger players, which can lead to cash flow problems. 

    This is especially the case as workers and materials generally need to be paid in advance and stage payment programmes can be vulnerable to delays. For instance, if a key project milestone isn’t met, then the construction firm could be left short of capital for salaries. 

    Construction invoice factoring can relieve some of this pressure. A common model is that a lender will factor against the business’ applications for payment, which is basically a project’s payment schedule. This type of factoring allows businesses to receive a major part of the payment for a completed job in advance.

    Body Shop Invoice Factoring

    As many of us know all too well, insurers can drag their feet when it comes to paying out. This is an issue that particularly affects the automotive industry, as they will often perform repairs that insurers will want extended credit terms on.

    Body shop invoice factoring is a financial product designed for accident repair companies whose customers are insurance companies that cover the damaged vehicle. With body shop invoice factoring, garages can maintain cash flow while they wait for insurance claims to go through.

    • Most B2B Sales Companies
    • Haulage, Logistics, Shipping & distribution
    • Manufacturing and Engineering businesses.
    • Printing & Packaging
    • Recruitment Agency & Consultants
    • Body shop and accident repair garages
    • The Construction Industry, including those operating within contracts
    • Business Supply & Business Services
    • Advertising, Media and Marketing
    • International Trade or Import and Export
    • Wholesalers

    Is Invoice Factoring Right for my Business?

    Companies of varying sizes and remits can access invoice factoring. Usually, businesses that experience one or more of the following scenarios find invoice factoring useful:

    • If sales are increasing and cash flow isn't keeping up.
    • You are moving into credit sales for the first time and you want help to manage your workload
    • If you have money tied up in your sales ledger that you could put to better use.

    These scenarios are often experienced by small companies or ventures that are just starting out, so specialist small business invoice factoring products are quite commonplace.

    To apply for invoice factoring, the lender will ask the applicant to fill certain requirements. Generally, this will be a minimum annual or projected turnover. Confirmation of who your customers are and that the debt is factorable along with your Companies financial information.

    A Breakdown of Key Factoring Benefits

    • Access to 95% of the value of your invoices.
    • Receive funds as fast immediate transfer
    • If you or your business has bad credit but you have a strong debtor ledger you will still be considered.
    • Free up cash for strategic investments
    • Assistance with credit control.
    • You'll get the support of a dedicated Relationship Manager
    • It reduces the time spent on credit and ledger administration.
    • If you choose a global institution, you could take advantage of multilingual representatives.
    • The option of protection from bad debts
    • You don't have to move banking providers to take out Invoice Factoring
    • Can be an excellent way of funding an MBO, MBI, Corporate Restructure or diversification.

    What Invoice Factoring won't do & the Negatives

    • It will not rescue a fundamentally failing business
    • It will not turn business losses into profits.
    • Invoice Factoring is not a solution for invoices that have already gone beyond your terms
    • If you don't work well with others you may not enjoy someone else handling your credit control.
    • Challenges can arise if a customer regularly goes beyond terms, friction between them, you and the lender could happen
    • Requested or required credit limits may not be granted against specific customers.
    • Invoices without supporting evidence such as delivery note or signed timesheets may be disapproved
    • Material breaches of your agreement could cause your account to be frozen or exceptional cases repayment demand
    • Factoring Companies will not typically fund invoices where terms are >120 days
    • Complex and heavily contractual sales/delivery processes don't typically work well.

    Basic Exclusions and Important Notes

    It is important to note that certain types of debt are excluded from most invoice factoring agreements. Every agreement is bespoke, but usually, exclusions relate to countries or customers with sanctions against them by HM Treasury or the US Treasury’s Office. Goods sold on sale or return are challenging, goods or services invoiced in advance of delivery. 

    You will need to keep records to prove the debts and make these available to the lender should they request them. This typically includes relevant purchase orders, contractual terms and acknowledgements, signed delivery notes or timesheets, invoices and other documents which evidence the money owed.

    Invoice Factoring FAQ's

    Invoice factoring is not regulated by the Financial Conduct Authority (FCA) or the Prudential Regulation Authority (PRA). A trade body called UK Finance does impose and monitor self regulation.

     

    The Standards Framework sets and enforces the standards that clients of UK Finance’s IFABL Members can expect when using them. Read more here along with how to make a complaint. 

    Yes, start ups or new companies can utilise the benefits of invoice factoring. 

     

    N.B. You would be wise to make sure your business sales and therefore invoicing is about to take off or it would be a pointless exercise. 

    The cost of invoice factoring is normally divided between the service fee and the discount charge. As a combined charge this can fluctuate but average fees are between 0.75% - 3.45% of the invoice value. 

    The longer you borrow the more money e.g. 90 days (credit terms) the more likely your costs will be higher. 

    Other factors such as the financial strength of the customers, your balance sheet, the complexity of the debt, credit insurance limits all contribute to the price risk calculations. 

    The discount rate is interest rate at which the money is borrowed at. Typically bank base plus a margin. 

    The factoring service charge is expressed as a percentage of turnover and this covers the standard administrative costs for the facility and outsourced solutions for your credit control functions. 

    Yes, a good proportion of invoice factoring companies will consider businesses that have picked up bad credit. The strength of an application often centres around the debtor ledger. 

     

    Adverse credit such as county court judgements or defaults should always be accompanied with a sensible explanation and/or a repayment proposal may be required. 

    Potentially yes, Companies that have arrears with HMRC may still apply for factoring. However, the lender will won't to see an agreed arrangement to repay in place and that you are sticking to it. 

     

    Companies with more serious HMRC arrears including facing a winding up petition may still receive support from specialist factoring companies. As long as a clear rescue path is outlined and the owners are clear & transparent. 

    UK Companies Contact Enable Finance to Discuss Invoice Factoring Options

    Invoice factoring is a great way to keep your business liquid. With access to up to 95% of the value of your invoices in a short timescale, you can be confident you will have the cash available to keep on top of your books and invest in the business. If your facility is up for renewal, invoice factoring is a flexible, good value option.

    Enable Finance is passionate about helping businesses grow. With access to funding programmes with over 225 lenders, we can match you with a product that’s right for you. We have nurtured relationships with our lending panel over several years, so you get the most favourable terms and conditions than if you were to deal with them directly. For more information on invoice factoring options, contact our team