Invoice Finance and invoice factoring in particular, is an alternative type of business finance that’s popular in the UK, but still widely unknown to many people and businesses. As a result, there are often lots of questions surrounding it, frequently coming from those considering it as an option for their enterprise. In this article, we’re going to answer some of the most common questions encountered when it comes to this type of business finance.
Invoice factoring FAQs:
- How does invoice factoring work?
- Why do companies use invoice factoring?
- What is the difference between invoice finance and factoring?
- What is an invoice factoring fee?
1. How does invoice factoring work?
Invoice factoring (also known as debt factoring) is fairly straightforward type of finance, even though it’s very different from loans and overdrafts.
How it works:
- You supply goods and services to your customers.
- You send your customer the invoice made payable to the invoice finance provider and send them a copy.
- You will then receive up to 90% of the invoice amount. At this stage, a service fee is deducted from your account as a percentage of your turnover.
- The customer settles the invoice in full by making their payment direct to the invoice finance provider. When the remaining balance is paid, a small finance fee is deducted from your account, charged as a percentage of the amount lent
- This invoice clears and you receive the remaining 10% balance minus the finance fee.
It’s worth noting that there can be different types of invoice finance that change the way the products works slightly, so it’s always important to ensure you thoroughly understand the particular products that you are considering.
2. Why do companies use invoice factoring?
Invoice factoring is primarily a tool for combating the cash flow problems that arise from late invoices. This can be a major strain on small businesses in particular, where they have their own suppliers to pay, or payroll and other monthly costs.
Large amounts of money can be tied up in unpaid invoices, and if this remains so for long periods, it can be particularly challenging. A lack of cash flow is also a barrier to expansion and growth.
The fact that the finance provider handles credit control is also a major attraction for small businesses and startups in particular, because it means that they don’t have to worry about investing in resources to handle it themselves. They don’t need to have their accounts and finance employees spend time chasing invoices, nor do they need to hire additional people to do it.
3. What is the difference between invoice finance and factoring?
It’s easy to get confused between the different terms relating to these products, but it’s important to know the difference.
Invoice finance is a broad term that covers all types of finance that lend against invoices. So in this sense, invoice factoring is simply a type of invoice finance, but it’s not the same thing.
You’ll also commonly see invoice discounting mentioned, which is again just another type of invoice finance, and is in many ways similar to factoring, but has a more confidential nature and does not service a business’ collections requirement.
4. What is an invoice factoring fee?
There can sometimes be different ways in which a provider will charge for invoice factoring, but in most cases there will be two or three points at which there are costs.
There’s a service fee , which is the fee for carrying out the various administrative and collections aspects of managing the account, and this is generally charged monthly or per invoice. It’s usually calculated as a percentage of the company’s turnover or outstanding invoices, so larger invoices and invoice volumes can generally mean a higher overall cost, but lower per pound lent.
There’s also the finance fee itself, which is similar to loan interest, and is charged on each invoice based on the amount.
Some providers will also have a setup fee. It’s always important to thoroughly check all costs associated with a factoring product, especially when comparing different providers.