One of the greatest challenges as a small business owner is maintaining a healthy balance between cash flow and operational costs, from paying employees to stock procurement. When clients fail to pay invoices within a reasonable window, this becomes even more difficult. Even outside of the late payment problem – half of UK businesses have paid suppliers late, at a £4.8bn cost to the economy – typical payment terms sit between 30 and 60 days. Some suppliers even operate on 90-day agreed terms. The result is poor cash flow, which severely limits growth prospects.

What is invoice financing?

Invoice financing has emerged in recent years as a popular alternative to banking services for SME owners seeking cash tied up in unpaid invoices. Built on the basis that invoices are assets, invoice financing allows firms to access funds that have not yet been paid.

Example

Sonny has submitted an invoice to a client for work worth £2,000. However, he has agreed on payment terms of 30 days, but has his own suppliers to pay before then. An invoice financing provider has agreed to pay him 90% of the invoice up-front, which lands in his account within days.

Invoice value: £2,000

Advance total (90%): £1,800

Fee (3%): £60

Once the client pays the invoice, the lender receives the £2,000 total. After deducting the £60 fee, Sonny receives the remaining £140.

There are two main types of invoice financing – discounting and factoring. Most invoice financing companies provide both kinds, but these are key differences.

Invoice factoring

Invoice factoring means receiving a certain % of your invoice from a finance provider, which will chase payment on your behalf. Some factoring companies use a “confidential” service to chase payment under the name of the recipient. Payment is made directly to the factoring company, which will pay you the remaining balance – minus fees – upon payment.

Invoice discounting

Like invoice factoring, the provider pays the money up front. However, under discounting the recipient is responsible for chasing payment from the client. In return, fees are generally lower than invoice factoring.

Typical eligibility criteria for invoice financing

Almost any trading business can access invoice financing, from sole traders to growing SMEs. As long as you are a B2B company – i.e. your customers are other businesses – you are eligible for some kind of invoice financing.

UK providers of invoice financing

Case study: Moduflex Limited

Two years ago, Bristol-based furniture manufacturer Moduflex Limited signed up to an invoice discounting package with RBS Invoice Finance (RBSIF) to assist the firm in opening a second production facility.

The new workshop enabled Moduflex to increase production capacity, improve product quality and produce new product ranges. Richard Blunden, Moduflex Limited managing director, said the financing facility allowed the manufacturer to achieve its growth plans.

“We are really pleased with the improvements to our production capabilities which will enable us to work towards our ultimate business objectives of expanding our product lines and achieving overall business growth,” he explained.

The discounting facility supported the company through two major changes in 2016 – the buyout of previous shareholders and the new factory. Blunden said the facility enabled expansion without the business worrying about working capital.

“The Facflow facility that we have with Invoice Discounting has also been invaluable. It allows us to monitor our cash receipts and we can access it 24 hours a day, seven days a week. It works in real time and there aren’t any delays in showing financial information so it helps us monitor cash flow effectively.”

What to watch out for (the fine print)

The fees associated with invoice financing mean that you limit your profitability. You really need to ask yourself, “how badly do I need this cash advance?”. An invoice finance facility could also limit access to other forms of business funding, as an unsecured loan will affect your credit rating.

Invoice financing can be expensive, and other forms of financing, such as a business overdraft, may be more suitable for a company that can foresee a cash flow shortfall in the near future.

Are you a consumer business? As invoice finance providers typically only serve B2B companies, those looking to sell consumer invoices may struggle to find a financier.