Invoice Financing Explained

Invoice Financing Explained

Invoice financing is an often ignored or misunderstood way for companies to expand and grow. An asset-based working capital solution, it is where third parties agree to purchase unpaid invoices for a fee, allowing enterprises in need of hard capital to get an advance on the money they’re owed by customers.

The parties who purchase these outstanding debts are known as invoice financiers ranging from well-known high street banks to more bespoke, independent lenders. To get the full range of offers from the best lenders in the invoice finance market, you may want to speak to a broker such as Touch Financial.

In the UK, two different types of invoice financing exist: factoring and invoice discounting.

Factoring 

Debt factoring is where invoice financiers manage a company’s sales ledger, assuming the responsibility of collecting customer debts. Each time a debt is created, the institution will buy it from you, up to 100 per cent of its total value at the time of purchase.

Once the debt is collected, the full amount becomes available to the original owner, with interest and fees charged for the service. This means that if you sell an invoice for £5,000, you would initially receive £4,250 (85 per cent of the debt), with the remainder available when the money was received, minus any interest or fees owed.

The main advantage of invoice financing in general is that it can provide an often large and immediate, increase in your cash flow. Factoring also reduces your responsibilities by handing control of your sales ledger to an outside body, thus freeing up some of your precious time.

Further, invoice financiers will perform credit checks on potential customers for you, so you’re less likely to transact with people who will default on their debt.

However, that’s not to say that the practice is without its drawbacks. Profit will, of course, be reduced, as your outgoings will be higher because you’re paying for the service you’re receiving. It can also restrict your access to other forms of funding (ie, an overdraft), as you won’t be able to use your ‘book debts’ twice over, so lose them as a form of security that can be promised to other lenders. Factoring has the added disadvantage of allowing a third party, rather than you, to liaise with your customers. Should they deliver a poor service, this will reflect badly on you.

Invoice Discounting

Invoice discounting works a little differently to factoring, in that the invoice financier does not take control of managing or collecting debts, but rather lends money against them (generally an agreed percentage of their total worth). A fee is charged for this service.

Once your customers begin to repay you, the money you receive is transferred to the invoice financier, to reduce your debt and allow you to borrow money on invoices from new sales up to the agreed amount

One advantage that invoice discounting has over factoring is that third parties will not be liaising with your customers, meaning that you alone are responsible for customer service and building your reputation. The fact that you retain full control over your own accounts, although it creates more work for you, can also provide you with a better overview of your business and how it is running.

Invoice financing is a much-underrated yet highly useful tool for those businesses that need immediate access to funds. By borrowing against promised future debts means that it poses a much lower risk of leaving you out of pocket than alternative finance options, making it an ideal choice for businesses, particularly for quickly growing firms such as startups, that are looking for a little help.

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