The Complete Guide To Invoice Factoring:
What is invoice factoring?
Invoice factoring (also referred to as debt factoring) is a type of invoice finance that enables businesses to sell their invoices to a factoring company for a percentage of their total value. When money is lent against a business’ unpaid invoices, the majority of owed money can be received upfront, eliminating the weeks or months it would have taken to get the invoices paid.
- The factoring company takes responsibility for chasing and collecting unpaid invoices.
- Accounts receivable financing that best suits businesses experiencing lengthy invoice payment terms.
What is invoice finance?
Invoice factoring comes under the umbrella term invoice finance, which is the process of borrowing money to cover the number of unpaid invoices that clients owe your business. This funding solution, offered by invoice factoring companies such as Penny, aids businesses in maintaining cash flow, enabling suppliers and employees to be paid on time and daily business operations to continue running smoothly.
Unpaid invoices signify money that is owed to your business, invoice finance helps to cover this intermediate period which means your business won’t be out of pocket whilst waiting for payment terms to elapse. The main types of invoice finance are:
- Invoice factoring
- Invoice discounting
- Single invoice / spot factoring
Invoice discounting vs. factoring
Invoice finance is most commonly structured through factoring and discounting. Factoring involves you selling your business’ outstanding invoices to an invoice finance provider, who will typically pay you between 70 - 85% of the invoices’ overall value upfront. It is then the lender’s responsibility to collect the invoice payments, and once they have received full payment from your customers, they will return the remaining 15 - 30% of invoice amounts to your business. Invoice factoring companies charge interest and a fee for their services.
On the other hand, with invoice discounting the business is expected to collect the invoice payments themself. The invoice finance provider will then advance up to 95% of the invoice amount and once clients or customers have paid their invoices, the business is expected to repay the lender the amount borrowed plus the discount charge.
How does invoice factoring work?
Invoice payment terms can be lengthy, running up to 90 days. This means that businesses can often wait for up to 3 months before receiving money that they’re owed. With invoice factoring, there’s no need to wait weeks or even months for the invoices to get paid, invoice clients can be approved to borrow the invoice value within hours. Like most alternative funding products, invoice finance has been designed to be quick and simple for business owners to apply for.
- The first stage involves collecting together your invoices and providing the details electronically to the factoring company.
- Once your business’ documents have been analysed you will be sent an agreed percentage to lend with the terms of your invoice factoring agreement.
- Whilst some lenders chase the invoice payments for you, others will expect you to follow-up as usual and once the invoices get paid, you will receive the balance minus any agreed fees.
Am I eligible for invoice factoring?
The eligibility criteria for this type of finance differs from a standard bank loan. Each factoring company has their own requirements, but as a general rule of thumb when selling invoices to a third party:
- Your business should be registered in the United Kingdom
- Have a business owner over the age of 18
- Your customers have a solid payment history and credit record
- A minimum volume of invoices (the minimum varies between lenders)
During the application process, it’s likely that you will also be asked for your business’ trading history, 12 months of business bank statements and related documents to give the lender a better overview of your business and whether you will be able to pay back money owed. Factoring companies will often favour businesses that are able to provide them with:
- A detailed list of their customers and clients
- Financial records for auditing purposes
- The outstanding invoices that need to be funded
How do I get small business invoice factoring?
According to the Federation of Small Businesses, roughly 50,000 UK SMEs become bankrupt and go under each year as a result of late-paying clients, costing the economy a huge £2.5 billion annually. What’s more, a study of over two million invoices found that the average small business owner is owed £24,841 in late payments on any given day. To receive small business invoice factoring:
- Step 1: Submit your application with all details of your invoices to the provider to determine whether or not your business is eligible for factor finance.
- Step 2: The factoring company will assess your application and decide how ‘risky’ lending money to your business is. Once a decision has been reached they will provide you with a quote that will reveal how much of the value of the invoices they are willing to buy upfront.
- Step 3: After you have agreed to the lender’s terms, you will receive the bulk of the money from the sold invoices and credit control becomes the lender’s responsibility.
- Step 4: Once your clients’ invoices have been collected and paid, the lender will pay you the remaining balance of money, minus any fees and service charges.
What is a service charge?
A service fee is paid to the factoring provider for their ongoing service to your business. It covers all administration, collections and management costs and is calculated via your factorable turnover.
What is credit control?
Credit control is the name used for the service that invoice factoring providers carry out on behalf of businesses. Factoring providers employ ‘credit controllers’, who are responsible for managing the credit control of the business and chasing payment from clients.
This system is not unique to factoring companies - most businesses that trade on credit perform credit control to ensure payments are sent on time. If a customer or client misses their invoice payment deadline, credit control is responsible for sending reminders, and taking legal action when necessary to ensure all debts get paid off.
What are the benefits of invoice factoring?
Not only does invoice finance enable daily business operations to continue without strain, it can also enable planning for growth. Some of the main benefits of invoice factoring include:
- Fast access to cash: Receive up to 85% of your invoice in just 24 hours.
- Reduce administrative pressures: Save time spent chasing late payments.
- Maintain customer & client relationships: By allowing an invoice provider to chase payments.
- Improve cash flow: Reduce the time taken waiting for lengthy invoice terms and increase your working capital.
- Fund business growth: Enabling you to take advantage of business opportunities as and when they come.
- Bad debt protection: Eliminate risk from customer insolvency.
What are the best invoice factoring companies UK?
There are a number of factoring facilities to choose from, we’ve rounded up the top 10 best invoice factoring companies in the UK for 2020:
| Factoring Company | Eligibility (annual turnover) | Advance Rate | Service Fee |
|---|---|---|---|
| Aldermore | £60,000 | 90% | 0.25 - 3% |
| Bibby Financial Services | £100,000 | 90% | 0.5 - 3.2% |
| Hitachi Capital | £50,000 | 85% | £250 fixed fee |
| Ashley Business Finance | £50,000 | 90% | 1 - 3% |
| MasketInvoice | £100,000 | 90% | 0.2 - 3.5% |
| Metro Bank SME Finance | £100,000 | 85% | 1 - 3% |
| Skipton | £100,000 | 90% | 1.35 - 3.5% |
| Close Brothers | £250,000 | 90% | 0.5 - 2% |
| RBS FacFlow | £250,000 | 90% | 0.0 - 5% |
| Lloyds | £250,000 | 90% | - |
- NB: This list is by no means extensive, please take it as a starting point for your research on factoring companies. Each provider offers their own fees, structures and terms that should be considered before making any decisions.
What invoice factoring costs can I expect?
It’s important to understand that factoring providers rarely ever charge one flat rate for their services. Rather, invoice factoring consists of different variables including invoice volume, creditworthiness, industry type and business stability. If your business is perceived as ‘low risk’ in the eyes of the factoring lender, and you have a large number of invoices that need to be factored, you can benefit from more competitive rates.
A higher volume of invoices suggests a constant stream of invoice payments to the factoring provider, making the arrangement far more cost-effective. The size of the invoice is also important, as larger single invoices incur less processing fees than multiple small invoices.
Credit checks are used by invoice factoring providers during the application process to determine your creditworthiness. If your business has a good credit score, chances are you’ll be able to benefit from lower rates.
Rates can also be industry dependent. Certain business sectors are perceived as lower risk from the onset because their payment terms are usually simple and straightforward. High risk industries are often labour intensive where the variables are more tumultuous and invoice payment dates less clear. The main invoice factoring costs are:
- Transaction fees: These include fees charged to process the payments made between your business, your customers and the invoice factoring provider. Charges apply for credit and debit cards, BACS payments and wire transfers.
- Set-up fees: These vary lender to lender but cover the cost to set up your business with your chosen invoice factoring provider.
- Overdue fees: When invoices expire and still need to be paid, charges for each day payment is overdue can apply until the money is repaid in full.
- Administration costs: The invoice factoring provider will conduct a variety of services including audit charges for business documents and application fees to process final statements.
- Early termination fee: There is usually a 28-day notice period for invoice factoring. If your business chooses to terminate its contract with the factoring provider early, you may be charged an early termination fee.
- Annual fees: For invoice factoring contracts that start from 12 months, an annual fee will cover the cost of keeping the facility open for one year.
Is invoice factoring a good idea?
Invoice factoring is an essential solution for businesses suffering from lengthy periods of unpaid invoices. Having a huge impact on cash flow, invoice finance provides funds to cover the short term, enabling business activities to continue as normal. If you have an extensive list of customers to pay invoices, this may be worth considering. With that being said there are both pros and cons to this product that should be understood before making any decisions.
One benefit is that factoring companies typically offer businesses bad debt protection for a small extra cost, which is an additional service definitely worth considering. Usually, these rates range between 0.5 - 2% of your business’ annual turnover. Bad debt protection is a form of non-recourse factoring where the factoring provider can take on the credit risk of your clients’ unpaid invoices, protecting up to 95% of your debtor balance.
You should also be aware of the fact that invoice finance is currently unregulated in the UK, which means that you are not protected in the same way you are with consumer finance products. However, the Asset Based Finance Association is the leading trade body for factoring companies. ABFA’s members follow a strict code of conduct to ensure responsible lending, and consumers have access to their independent Ombudsman for any issues.
Invoice Factoring FAQs Frequently Asked Questions
If you want to learn more about invoice factoring, then make sure to checkout our FAQs below for more information.
What is invoice finance?
Invoice financing is the process of borrowing money to cover the cost of unpaid invoices of clients who owe the business money. It essentially means that a business can still pay its employees and receive cash flow whilst they wait for their invoice to be paid.
What is invoice factoring?
Invoice factoring is where a business sells its outstanding invoices for a smaller percentage of its total value to an invoice factoring company. The invoices are bought by the invoice factoring company who chase and collect the unpaid invoices. As the money is borrowed against the business’ unpaid invoices, the business can receive a proportion of the money upfront and do not have to wait around or risk not getting paid at all.
How can I get invoice factoring for my business?
To receive business invoice factoring you need to submit an application with details about your outstanding invoices. The application will then be assessed for how much risk is involved to lend to your business.
If successful, you’ll be given a quote on what percentage of the invoices the lender will buy upfront, you will then receive that money. It is then the responsibility of the lender to chase the outstanding invoices from clients. Once the invoices have been collected and paid, the lender will repay the remaining balance, minus any fees or charges that accrue.
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