How Does Invoice Financing Work?

Alternative forms of business funding can be difficult to grasp comprehensively. Due to the long list of terms — such as invoice finance, debt factoring, single invoice finance, and invoice discounting — a lot of confusion can arise. Although seemingly similar, the above terms refer to completely separate services.

To eliminate ambiguity, we’ve created a guide that covers everything you need to know about invoice financing if you are a recruitment business of any size, a consultancy who places contractors or an online labour marketplace. This guide includes:

• Where invoice financing fits in the vast array of funding solutions. 
• How invoice financing works.
• The pros and cons of this service.
• Whether this option is the right choice for your business. 

Let’s break this down. 

What Is Invoice Finance?

Starting with invoice finance: This is best described as an umbrella term for the various types of funding solutions. 

Invoice finance companies offer short-term financing solutions specifically designed for B2B businesses that trade on credit terms. These facilities essentially offer a form of loan that allows your business to borrow money against outstanding customer invoices. The most common types of funding are:

• Debt factoring
• Selective invoice finance
• Invoice financing

When customer invoices are created, there’s usually a notable gap between the making of the agreement and the time at which the customer settles their invoice. This can take anywhere from around 30 to 120 days. For all finance options, the lender closes this gap by advancing a large percentage of the accounts receivable finance. 

Accounts receivable finance refers to the balance of money your customers owe to the business, meaning the company pays a large portion of your overall value upfront; sometimes within just 24 hours of the invoice being accepted. 

Providing businesses that use payment terms with a straightforward funding service gives them easy access to working capital, which lets them seize new growth opportunities. That’s why invoice finance has become such a popular alternative when compared to traditional solutions such as banking loans and overdraft facilities. 

Many companies with imperfect credit, a short trading history, or any other challenging circumstances are held back from benefiting from conventional funding solutions due to the high standards required to qualify. These alternative lenders combat this common issue by making funding more accessible.

In fact, invoice finance facilities offer a particularly high rate of approval relative to traditional banks, making it an accessible funding solution. According to Biz2Credit research, large-scale banks approved 14.5% of loans and smaller banks obtained an approval rate of 20.3%. However, alternative lenders achieved an increased figure of 26.3%.

Types of Invoice Finance

While these services have a lot of similarities, they all operate slightly differently. Here, we explain the various forms of invoice finance:

Invoice Factoring

Otherwise known as debt factoring, invoice factoring is a service that involves selling your entire sales ledger to a funding facility at a slight discount. By making this transaction, you forfeit many key responsibilities associated with ownership of invoices, including chasing customer collections and receiving direct payments.

Outsourcing invoice collections makes your customers aware of your association with a third party since it’s the factoring company that gets in contact regarding their outstanding agreements with your business. It is important to choose your provider wisely, as you don’t want this to impact your working relationships with valuable clients or other stakeholders. It’s best to work with a reputable financier, who will follow the right processes when contacting your clients. Also, working with the wrong provider could lead your clients to view this as a sign your organisation isn’t stable enough to be supported by leading funders.

Since the lender assumes control over your invoices, this solution is more suited for companies with a limited trading history or smaller turnover.

Selective Invoice Factoring

Selective invoice factoring, also referred to as single invoice finance or spot factoring, is very similar to debt factoring, but it offers more flexibility. Instead of selling your entire sales ledger, you only sell the specific invoices or customer accounts you want to factor. However, this selection means you don’t get the same value for money when compared to other forms of invoice finance.

If you’re a new business with limited trading history, it may be better to choose the other funding options.

Invoice Financing

Invoice financing, invoice discounting and accounts receivable financing are all interchangeable terms that refer to this individual service. With invoice financing, the funding facility lends your business a large percentage of money outlined in your outstanding invoice. This gives you immediate access to cash to make investments and pay off operative expenses but comes with an attached interest rate.

Since you’re not selling your unpaid invoices, like with debt factoring, you remain in full control of your sales ledger, so you can continue to chase and receive customer payments directly. This service lets you maintain full confidentiality around using third-party services, which means your client relationships won’t be impacted by this funding option.

Due to the sustained responsibility of the sales ledger, invoice financing is more suited to well-established businesses with teams that can chase collections reliably and independently.

The Invoice Financing Process

Invoice discounting is a simple process that only involves six steps:

• Send Your Application

The first step is to apply for an invoice discounting service with an established and reputable finance provider. You’ll need to submit some documents to be considered, such as your invoices, customer details and financial statements.

• Get Approval

Once your application is approved, the invoice financing provider will assess the creditworthiness of your customers. This is a crucial part of the process as the risks associated with the customers’ ability to pay directly impact the level of funding you get access to.

• Submit Your Invoices

When you reach an agreement with the finance company regarding your advance percentage, you then submit your invoices for funding. Depending on whether you go with spot factoring or full invoice financing, you’ll need to either send your entire sales ledger or the specific invoices you selected.

• Receive Capital

The finance provider gives you the pre-agreed advance percentage of the invoice value. This typically only takes 24 to 48 hours, giving you instant access to capital to make the necessary investments and pay outstanding expenses. 

• Payment Collection

Since you remain in full control of your invoices, your accounts team then communicates with customers directly to nurture working relationships and collect payments punctually. 

• Invoice Repayment

Once your customers finalise their invoices, you immediately return the funds to your finance provider. The remaining percentage of the invoice is then transferred to your business, minus any associated fees or service charges.

Invoice Financing From the Lender’s Perspective

From the invoice financing company’s point of view, providing service benefits them, as invoices act as a form of collateral. The tried and trusted discounting process limits most of the associated risks by rarely advancing the full invoice value. However, it still entails some risk for the lender as there’s no guarantee that customers will meet their payment agreements, which impacts clients’ ability to pay back their loans.

Pros and Cons of Invoice Financing

Before utilising invoice financing, it’s best to understand both the positives and negatives associated with these services.

Advantages of Invoice Financing

Some of the key benefits invoice financing has to offer include:

Quick Access to Cash

Invoice discounting eliminates the long time gap to receive customer payments. Instead of waiting weeks or even months to get cash, you obtain a majority of the invoice value upfront as soon as 24 hours after submission. This enables your business to optimise its cash flow and make valuable investments.

Effective Invoice Management

Some invoice financing providers offer accounting software, which sends you reminders to chase customers facing upcoming payment deadlines. This gives you a comprehensive overview of your sales ledger and equips you with the tools to manage invoices effectively.

No Fixed Assets Necessary

There are no requirements for you to provide assets as security for the loan with invoice discounting, which can be beneficial to businesses that have a small number of fixed, physical assets.

Ongoing Benefits

The advance percentage is mostly based on the risk associated with the customers’ ability to pay, as well as the total value and quantity of your invoices. So, as you continue to use this service, the risk associated with your customer payments will decrease, and the amount of funding you can access increases as a result.

No Credit Requirements

Although aspects of your company’s credit history are taken into consideration, discounting facilities tend to base their decisions on your customer’s creditworthiness and invoice value. This means your credit history won’t be a primary determining factor in whether you get accepted for funding, making invoice financing a highly accessible solution.

Maintain Strong Customer Relationships

Unlike debt factoring, your company remains in full control of your customers, meaning you get to chase up your customers and maintain valuable relationships with them. Since your business remains the rightful collector of the invoices, clients won’t be aware that you’re using funding solutions and your brand reputation won’t be affected as a result.

Disadvantages of Invoice Financing

It’s important to stay informed on the following drawbacks of invoice discounting: 

You Only Receive a Percentage

Using these funding services means that you don’t receive your full invoice amount. The benefits of invoice financing come at a small cost as the lender deducts the service charge and interest accordingly. 

Credit Checks Still Apply

As mentioned, credit checks aren’t a large factor in whether your application gets accepted, but they do still play a small part. Depending on whether you choose recourse or non-recourse financing, your company may be liable if customers don’t finalise their invoices, which could cause monetary setbacks.

Can Be Costly

Discounting fees tend to have higher costs than traditional business loans, so it’s important to assess whether your business can afford these fees. Make sure to compare prices from a selection of providers to get the best value for your money.

Invoice Financing Costs

Invoice financing isn’t a set cost across providers. Discounting costs vary significantly per finance company, and individual factors of your business may also affect the expenses you pay, including:

• The industry of your establishment.
• Your company’s trading history.
• The value of your invoices. 
• The amount of invoices you require funding for.
• How long it takes your customers to pay.
• The risk of customer non-payment.

There are two main fees associated with invoice financing, which are as follows:

1. Service Charge: The administration and credit management costs.
2. Discount Fee: The interest charged on the credit amount.

If you’re outsourcing the responsibility of credit control, the service charge will be higher than if you keep payment collection services in-house. Additionally, if you wish to end your agreement before the end of the contract, you may need to pay additional costs, such as a termination fee. It’s also possible for other charges to arise, like costs for business finance checks, overdue payment fees and credit protection expenses. That’s why it’s critical to thoroughly evaluate the terms and conditions before getting tied into an agreement.

While prices are an important consideration when choosing your financing facility, you should take other factors into account, such as reliability and quality of service. So make sure to thoroughly research your finance options by reading testimonials and customer feedback.

Sonovate’s Platform: The Key To Success

Think invoice discounting is the best solution for your business needs?

If you are a recruitment business, a consultancy who places contractors or an online freelancing platform, Sonovate gives you the ideal invoice financing experience. Designed to reduce admin and save time, our flexible solution means you’ll be able to focus on the most important facets of your business. Choose between our all-in-one funding and back office automation platform, or simply using our funding to fuel your growth.

Here are just a few benefits Sonovate has to offer:

• Simple setup and integration
• Transparent pricing. No hidden fees or charges
• Flexible funding, request cash as and when you need it
• The more you invoice the more you can withdraw
• Automated timesheet submissions and follow ups
• Funding for permanent or contract placements
• Full visibility on your payments and collections
• Best in class reporting and reconciliation with your accountancy package
• 95% bad debt protection as standard.
• No long-term contracts.

How To Apply

Want to see Sonovate’s comprehensive solution for yourself? Book a short demo with us and meet with one of our experts who will introduce you to the platform at a time that suits you. Get started with Sonovate to empower your company like never before.