Invoice Factoring

Invoice factoring is when a business sells its accounts receivable to a factoring provider. The factoring provider gives your business a loan against the value of these outstanding invoices, allowing you to receive payment immediately rather than waiting for your usual customer credit terms. The factor company will also manage the collection of these invoices directly unless you choose a hybrid form of factoring called CHOCs (customer handles own collection service).

1. Assess the risk of the loan 

The invoice factoring specialist will need to assess the risk of giving you invoice finance. This means they need to assess the risk of not being paid in full. They do this based on the volume and size of your invoices, payment terms, the creditworthiness and payment history of your clients, the industry you are in, your company history and track record.

You can choose to speak to an invoice finance broker who can help you to identify the right invoice provider for you.

The factoring company will agree the amount of cash advance they can provide you with. This is usually a percentage between 75% to 90% of your accounts receivable (but it can be 100% in some cases.) They will provide you with a full quote detailing the terms of the agreement and any fees that are applicable. Once you have signed your agreement, you should receive your funds within 24 hours.

At this stage, the factoring company will notify your customers as is relevant and specific to the agreement that they are collecting your company invoices. This will include details of how, by when and where to pay them. You should be prepared to answer queries from your customers who may be concerned about the change in process.

When the invoices are paid, the factor company will send you the remaining outstanding balance of these less their fees. For example, you agree to £10,000 of invoices to go to the invoice factoring company. They provide you with a cash advance of 85% or £8,500 immediately. The remaining 15% or £1,500 less the discount charge and service fee, will be paid to you when your customer pays their invoice in full. You will resume direct invoicing and collection of your customers unless the invoice factoring agreement is extended or has a set fixed term yet to expire.

Invoice factoring can include some or all of the following fees:

• Discount charge – usually between 0.5% and 5% of the amount loaned and is charged weekly or monthly for the duration the invoice is unpaid
• Service fee – usually as a percentage of your company turnover
• Early payment fees – usually applies if you have a fixed term agreed for your invoice factoring
• Arrangement fee – a one-off that should be disclosed to you as part of your invoice factoring quotation.

• If your clients don’t pay the invoices, you may have to buy back the invoice from the invoice factoring company – see more in our section What happens if my clients don’t pay?
• Your reputation may suffer if the factor company behaves poorly in a way that doesn’t align with your company’s values.

To be eligible for invoice factoring, you will need:

• Ideally a turnover of at least £50,000, and there is even more choice for firms with £100,000 and above (start-ups may be considered by some factoring providers)To be trading with other businesses not individual consumers
• Credit terms and credit risk management processes that meet industry standards
• Evidence that invoices can be collected within reasonable timeframes
• A minimum number of invoices (and in some cases, a maximum may be set).

There are three approaches you can choose to take or not if you are concerned about the non-payment of your invoices. This will form part of your invoice factoring agreement.

1. Recourse factoring – under this option, any unpaid invoices remain your responsibility and not the invoice factor. As you have already received a cash advance for the invoice, you will be liable for these funds and will have to buy back the debt. This approach has the lowest risk for invoice factoring companies and hence the lowest costs associated with it to access the invoice finance.
2. Non-recourse factoring – in this example, the factor is liable for any unpaid invoices. However, this makes the risk of giving you a cash advance greater and comes with higher fees. You may also find it harder to find a factor willing to do this as they will be more stringent on their requirements to offer a factoring service.
3. Modified recourse factoring – the factoring provider will take out insurance for cases of non-payment from your clients due to bankruptcy or severe financial issues. Claims for damages or disputed invoices are not usually covered by this type of insurance. Collection of any unpaid invoices after the end date of the factoring agreement will remain your responsibility, including buying back of the debt from the factor.

If you choose any of these options, then your invoice factor may decide to place a proportion of your funds in an escrow account. If payment is not made as expected, they can access these funds to cover their losses.

• You will receive a smaller proportion of funds at the outset of your agreement
• You will incur higher costs for your cash advance
• You may have a reduced choice of invoice factoring companies to use.

Managing credit risk is something your company should already be doing – after all why provide services and credit terms to someone who is unlikely to pay you? In addition, your invoice factor will also help to vet and assess your customers to help minimise those invoices that may not pay on time.

Invoice discounting is when the unpaid invoices of a business are used as security for a loan. Invoice discounting companies will issue cash upon issuance of the invoices and thereby releases cash flow immediately rather than having to wait for customers’ usual credit terms (such as 30 days, 60 days or longer in some cases). Invoice discounting specialists will usually only lend up to 80% of your total accounts receivable that is younger than 90 days old.

To use an invoice discounting service, you will need to send the discounting company an accounts repayable report. From this, they can decide how much they are willing to lend to your business against the value of your outstanding invoices.

Invoice discounting does not include the running of your sales ledger and chasing for payment. This remains the responsibility of your business.

If your company has already used your accounts receivable as collateral for another finance arrangement, then you cannot use invoice discounting services.

The costs for invoice discounting can include a fee as a percentage of your turnover, a service fee and an interest rate on the amount of the advance.

Businesses with a turnover of £250,000 or more may find it easier to obtain invoice discounting, however there are some firms who will consider all businesses of any turnover, including start-ups.

Yes, new and small businesses can qualify for invoice finance. The minimum £50,000 turnover is likely to apply, but not in all cases, and your factoring provider may prefer you to be a homeowner.  

1. Taking invoice finance can impact your ability to obtain other forms of business finance.
2. Make sure you have a plan if your clients leave unpaid invoices.
3. Check your invoice financier is listed with the Asset Based Finance Association and UK Finance – these are industry bodies whose members agree to adhere to their codes of conduct.
4. Check if your invoice finance provider is listed with the Financial Conduct Authority (FCA). While invoice finance is not a regulated activity, many of the organisations offering this service are regulated for other associated services.
5. Consider using an invoice finance broker who can help you find the most suitable arrangement for you.

Our broker Touch Financial is a trading name of SFP Brokers Limited. These are authorised and regulated by the FCA. View FCA register.

Invoice finance is a form of short-term financing that is between a finance firm and a business. The finance firm provides finance to the business who sells its accounts receivable. The released funds improve the business’ working capital. Invoice factoring in one type of invoice finance, with another being invoice discounting.

• Invoice factoring places responsibility for chasing invoices to the factor, whereas this remains with the business for invoice discounting.
• Customers are aware that a third party is involved with invoice factoring, whereas they don’t with invoice discounting.
• Customers pay the invoice factor direct, unlike invoice discounting where they pay the business in the usual way.

If you’re looking for a different kind of business finance help, you may want to go to our business loans, commercial mortgages, property development finance or bridging loans pages.