Invoice finance is a maligned and misunderstood form of business finance, and it’s easy to see why. The industry-standard jargon like ‘spot factoring’ and ‘invoice discounting’ doesn’t really help when you’re trying to work out which type is right for your business — but behind the tricky terminology, there’s a range of different ‘IF’ products that are useful for lots of different business situations.
First, let’s define ‘invoice finance’ itself. Instead of waiting for the duration of your payment terms, you ‘sell’ the invoice to a lender and effectively get paid faster for work you’ve completed, or products you’ve delivered.
In reality it’s slightly different, functioning more as a cash advance based on the value of the invoices involved.
For example, with an invoice worth £20,000 you could get an advance anywhere between £12,000 and £20,000, depending on a wide range of factors.
When your customer settles the invoice, they’ll usually pay into a trust account controlled by the lender, which may or may not be confidential. The details depend on which product you use — more on them in a moment.
After your customer pays, you get the remainder that wasn’t advanced minus the lender’s fees.
Each product and lender will have a slightly different pricing structure, but as a rule of thumb the advance amount will be around 85% with fees around 3% — so in this example, you’d receive 85% as an advance, and the remaining 12% after your customer pays.
Invoice factoring is perhaps the most-used form of invoice finance. Usually, factoring includes credit control, which means that as well as advancing you cash, the lender will handle your collections process.
This involves everything from the day-to-day management of your debtor book, to issuing reminders and chasing late payments.
Smaller businesses without dedicated credit controllers or finance directors often appreciate factoring, because the added credit control service can help reduce management overhead — and the directors can get on with running the business.
Invoice discounting (also known as ‘confidential invoice discounting’) is on the other side of the coin. Unlike factoring, with discounting your customers won’t know you’re using a finance provider — the service is completely confidential.
Although the lender might still control the account that your customers pay into, it’ll be set up in your name, so from your customer’s point of view it should seem like business as usual.
Because discounting is quite hands-off for the lender and they have less assurance your customers will pay on time, the creditworthiness of your clients matters more.
For that reason, discounting is normally used by larger, more established companies with corporate clients and a healthy monthly turnover.
On the subject of confidentiality, there is also a product offered by some lenders that’s confusingly called ‘confidential factoring’. As with standard factoring, the lender handles your collections process, but with confidential factoring they’ll interact with your customers as if they work for your company.
Selective invoice finance
Selective invoice finance is a general term for a few different subcategories of IF, but the key difference is flexibility.
With selective invoice finance you cherry-pick specific customer accounts that you’d like to finance, as opposed to financing your entire sales ledger as you would with factoring or confidential discounting.
This can be a real help for companies with a broad range of customers — you could finance the invoices from a big customer, but let your smaller invoices come in as normal.
Such flexibility isn’t available to everyone though, because your customer’s creditworthiness will be at the centre of the lender’s decision.
In other words, selective invoice finance might be an option if you’ve got a blue-chip or government contract, but it’s probably off the table if you’re dealing with a smaller business.
Yet another common term in invoice finance is ‘spot factoring’. This is similar to selective IF, but allows you to choose a specific invoice to finance rather than a specific customer. This arrangement is often useful for seasonal businesses, or companies that sometimes invoice for large contracts.
To adapt the example above, if you’d invoiced your blue chip client for one large piece of work and four smaller ones, spot factoring would allow you to get an advance for only the more valuable invoice.
As with selective IF, your client’s creditworthiness will matter most to the lender. And, you guessed it — with ‘factoring’ in the name, the lender will often handle the collections too.
There’s one last area to talk about in invoice finance, and that’s the alternative online products that have popped up in the last few years.
They’re usually variations of spot factoring with a peer-to-peer aspect added — you upload an invoice to their platform, and investors ‘bid’ to buy it in an auction-style format.
This can be a good way of driving down the cost to you — but given the competitive nature of this format, your business and client will be carefully scrutinised, and many smaller firms find these alternatives can’t help them.
Hopefully I’ve helped clear up some of the misconceptions of invoice finance, so you can wade through the jargon with confidence. I’ll end with a cheat sheet of all the terms I’ve covered.
- Finance entire sales ledger
- Credit control included (lender deals with your customers)
- Not confidential
- Good fit for smaller companies
- Can be more expensive
- Finance entire sales ledger
- Credit control not included
- Normally confidential
- Customers’ creditworthiness more important
- Suitable for bigger, more established companies
- Can be cheaper
- Selective IF — choose specific customer accounts to finance
- Spot factoring — choose specific invoices to finance
- Confidential factoring — lender handles credit control, but represents your company
- Non-recourse factoring — if your customer doesn’t pay, the lender will absorb the cost (usually more expensive)
- Online auctions — peer-to-peer spot factoring with an auction-style format
Conrad Ford is Chief Executive of Funding Options, recently described by the Telegraph as “the matchmaking website for small businesses and lenders”.