Invoice Factoring

Woman sorting through a pile of invoices at work

By Rob Binns | Senior Writer | Updated: 20 April 2021

What it is, how much it costs, and why it’s the fastest, most convenient way of boosting your business’ cash flow


What is invoice factoring?

Invoice factoring is a process in which a company’s unpaid invoices and other debts are sold to a third party (the ‘factor') in order to free up capital.

Invoice factoring can be provided by banks or independent finance providers. The invoice factoring service buys the debt for a large portion of it's value and assumes responsibility for chasing its full payment. When payment of the initial debt is received, the factor forwards the remaining balance on to the company, minus an agreed commission and transaction fee.

This process is also known as debt factoring or asset-based lending. Let's take a look:

how invoice financing companies work

Case study #1 | Hannah

It’s the end of the month and the bills are due at Hannah's small, Balham-based pizzeria. She has to pay her rates and her chefs’ wages, plus place new orders for drinks and ingredients. Money’s tight, and she’s still waiting to receive cash from an invoice for a big catering job she did for a function six weeks ago.

Hannah decides to bring in an invoice factoring company to help recover the £2,000 owed. The factor gives her 90% of the debt upfront, providing Hannah with £1,800 to ease her cash woes. Then, the factor chases payment of that invoice for her, freeing up Hannah's schedule to grow her business.

When the gig pays up a few weeks later, the invoice factoring company takes a small cut (say, 3%, or £60) and sends Hannah the remaining £140.

Sumptuous!


The benefits of invoice factoring

There are many benefits associated with invoice factoring and, depending on your circumstances, it can revolutionise the way your company works.

Your business can benefit from having more cash and time on your hands, as well as protection from bad debt and quicker customer payments. Using an invoice factoring service can also lead to a boost in public perceptions of your company and, most importantly, in profits.

Let's take a look at the benefits of invoice factoring:

 Improved cash flow

Collecting money can be a time-consuming process and when invoices aren't being paid on time, cash flow issues are bound to arise. This is especially true for larger operations, where significant sums of money can remain unattainable for long periods. Invoice factoring provides a quick financial boost that helps prevent issues associated with sluggish cash flow.

 More free time

Debt factoring essentially outsources the process of tracking payments, sending out statements and contacting those companies who are slow to conclude transactions. With no need to worry about outstanding invoices, you and your team can focus on running your business instead.

✔ Increased potential profitability

For most businesses, investment is the key to profit. With invoice factoring offering a fluid option for improving your cash flow, you can invest more capital, benefit from volume discounts and avoid the costs of late payment to suppliers. Even over a short amount of time you can boost profits substantially.

✔ Improved planning ability

If you don’t know when you’ll be paid, how can you plan ahead with any degree of accuracy? Debt factoring offers a guaranteed payment, which can be significant for companies whose profits are reliant on reinvestment.

Quicker customer payments

Invoice factoring services are professionals who are experienced in collecting payments, so customers are far more likely to settle invoices punctually. This level of professionalism can also have a positive effect on the way your company is perceived.

 Protection from bad debt

If you choose non-recourse factoring, you can protect yourself from bad debts, which are payments lost to insolvency or defaulting. A non-recourse contract means the factoring service takes on the responsibility of the debt.

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1. Have you used invoice factoring before? YES NO

Types of invoice factoring

There are two main types of factoring to choose from: recourse and non-recourse. The option that is right for you will depend on your company’s circumstances. Certain options are only available for certain operations, like businesses with a high turnover.

Recourse invoice factoring

The most affordable and straightforward option, recourse factoring requires you to carry the risk of bad debt. As the risk is minimal for the factoring service, this is the most practical choice for small businesses.

Less risk for the invoice factoring service also makes it more likely the company will release a larger percentage of the invoice's value. Why? Because it knows it can claim it back that money back if it has to.

If you're not sure if recourse invoice factoring is right for you, consider the reliability of your customer base. Have they paid in the past? Are you confident of getting the money back? If so, recourse invoice factoring is a cheaper, quicker solution for your business. If not, keep reading.

Non-recourse factoring

This option means the factoring service assumes liability for the debt if an invoice remains unpaid, which can happen when a company becomes insolvent or unresponsive. Unsurprisingly, this is a more expensive option; it comes with higher fees, and a lower amount paid upfront – which means less cash when you need it most. Non-recourse options aren’t available to all businesses due to the higher level of risk involved for the factor.

This option isn't suitable for all businesses. But should you have any worries about whether your customers can pay now or going forward, non-recourse factoring is something you need to consider.


Invoice factoring and Invoice discounting: What are the differences?

By this stage in your research, you've probably already heard the term ‘invoice discounting' knocking around with the ‘invoice factoring' we're focussed on here. While invoice factoring and invoice discounting are very similar, there are key differences – mainly relating to credit control. Do you want the responsibility of chasing payment of your unpaid invoices, or would you rather outsource it?

Invoice factoring involves the sale of your unpaid invoices to a third party factor. This factor then chases payment for you, and assumes responsibility for credit control, as well as receiving the payment.

The pros and cons of invoice factoring:

Pros:

  • Easier to get accepted for
  • Credit control is taken care of for you, and can help boost perceptions of your business
  • Provides an ongoing, highly scalable form of finance

X Cons:

  • Most factoring facilities are whole turnover, meaning you may have to factor your whole sales ledger (unless you opt for selective invoice finance)
  • Fees can be limiting and difficult to understand

Invoice discounting (also known as receivables discounting) also involves the ‘sale’ of your unpaid invoices to a third party to free up funds. However, unlike with a factoring deal, your clients won’t know that you’re receiving finance. You’ll still be responsible for collecting your own payments, and liaising with your clients to settle debts.

The pros and cons of invoice discounting:

Pros:

  • Usually less expensive than factoring, because you’re not paying for credit control
  • Confidential – your clients won’t know you’re using third party finance

X Cons:

  • You’ll need a higher turnover (around £100,000) to be eligible

Let’s take a look at another case study:

Case study #2 | Hayley

Hannah's cousin Hayley runs a growing interior design agency, turning over around £120,000 a year. Like her cousin, Hayley also needs a fast cash injection to help fund an expansion to a new office in Hackney Wick – so she too looks to utilise invoice finance.

Unlike her cousin, though, Hayley is more of a ‘hands-on’ type. She’s happy to chase her own payments, and would prefer it if her customers were blissfully unaware that she’s receiving finance. Hayley chooses invoice discounting to retain control over her sales ledger, and help maintain a handle on her client relationships.


Compare invoice factoring providers

Most of the major banks offer factoring services of one kind or another. However, rates and fees are not universal and you should do the research to make sure you get the best deal. Major banks in the UK that offer factoring include:

  • Barclays
  • HSBC
  • Lloyds
  • RBS
  • Santander
  • Standard Chartered

There are also many other financial services that offer factoring as part of their business – some even specialise in it. These businesses offer some of the best rates available and should always be included in any research into the subject. Some of the most reputable include:

  • ABN AMRO Commercial Finance
  • Aldermore
  • Ashley Finance
  • Bibby Financial Services
  • Calverton Finance
  • Close Brothers
  • Funding Options
  • Hitachi Capital Invoice Finance
  • Optimum Finance
  • Skipton Business Finance
  • Sonovate
  • Touch Financial
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1. Have you used invoice factoring before? YES NO

Are you eligible for invoice factoring?

Red highlighter ticking check boxes

As mentioned above, not all companies are able to obtain factoring services due to the risks associated with the practice. An invoice service will need to weigh up the potential losses with their ability to make a profit.

Usually a minimum annual turnover of £50,000 is required before a company is considered an appropriate client for a factoring company. However, there are also some more accommodating companies that will consider smaller businesses.

If a company has a small amount of customers, this magnifies the risk of bad debt and possible problems in the near future. Having a larger pool of clients and customers is seen as an advantage to a factoring provider. Likewise, proving that debts can be collected within a certain time frame may also be considered before a provider will agree to a contract.

Sometimes a minimum or maximum number of invoices must be involved. In the case of the minimum, it is generally not worth a provider taking on a contract that has such a small possibility for profit. Maximum numbers may also be implemented, especially if your company does not provide a certain level of stability, as this will minimise the factoring service’s risk.

Only B2B (business to business) ventures are considered for factoring. Contractors or subcontractors will require a specific form of construction finance, while recruiters can also benefit from industry-specific invoice finance solutions.


The cost of invoice factoring

With so many providers offering different levels of service, you can expect prices to vary considerably. Of the many things to consider and compare, pay close attention to discount charges, credit management fees and credit protection charges.

Discount charges

Similar to the interest you pay with a bank account, discount charges can be significant depending on the type of service you employ. These monthly charges are applied at a daily rate of 1.5-3%. Larger companies that sell invoices in greater numbers can often negotiate a lower percentage.

Credit management fees

Typically a fee of between 0.5-2.5% of turnover will be required for management and administration fees. The total is also informed by the volume of invoices and, much like the discount charges, can often be negotiated for larger projects.

Credit protection fees

Only relevant for non-recourse engagements, this fee is implemented for high-risk bad debts and rarely exceeds 2% of the turnover.


What can you expect?

As there are so many options available, you should make sure that the provider you have chosen is a reputable one. The Asset Based Finance Association (ABFA) provides a list of invoice factoring services, while also outlining a number of relevant requirements.

Once you've compared invoice factoring quotes to find the right company, you'll need to make sure you meet their preliminary qualification standards. Keep the relevant paperwork and information handy so the process is a smooth and efficient one.

Shortly afterwards, a contract will be drawn up that you should read thoroughly to make sure you understand your commitments. This contract will also confirm the minimum and maximum amount of invoices the company will allow – this depends on the circumstances and scale of your operation.

You will usually be offered an initial advance on your invoices, somewhere in the region of 85 -95% of their value. It is then the responsibility of the factoring service to collect the relevant payments from your customers.

Still not convinced? Read more about how invoice factoring compares to more traditional forms of finance – such as an overdraft – and how it can take your business to the next level.

Rob Binns Expert Market
Rob Binns Senior Writer

Rob writes mainly about the payments industry, but also brings to the table industry-specific knowledge of CRM software, business loans, fulfilment, and invoice finance. When not exasperating his editor with bad puns, he can be found relaxing in a sunny (socially-distanced) corner, with a beer and a battered copy of Dostoevsky.

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