What is invoice finance? A plain-English explanation

If your business sells to other businesses on credit terms, you already know the frustration. The job is done, the invoice is out, and the money arrives 30, 60 or 90 days later, sometimes longer. In the meantime, wages, suppliers and rent do not wait.

Invoice finance exists to close that gap. Rather than waiting for the customer to pay, a finance provider advances a proportion of the invoice value soon after it is raised. When the customer eventually pays, the balance is released to you, less the provider's charges.

The basic mechanics

1. You deliver the goods or complete the work and invoice your customer as normal.
2. The invoice details are shared with the finance provider.
3. The provider advances an agreed percentage of the invoice value to you.
4. Your customer pays the invoice when it falls due.
5. The provider releases the remaining balance, less their fees.

Because funding is linked to invoices, the amount available generally rises as your sales grow. That is the fundamental difference from a fixed loan or overdraft, where the limit is set at the outset and has to be renegotiated.

The main variants

Invoice finance is an umbrella term. The three forms you are most likely to encounter are:

• Invoice factoring: the provider advances funds and also manages credit control, collecting payment from your customers. It is usually disclosed.
• Invoice discounting: the provider advances funds but you keep control of your ledger and collections. It can often be confidential.
• Selective invoice finance: you fund individual invoices or customers as needed, rather than the whole ledger.

Which is appropriate depends on how your business runs. A firm without a dedicated credit controller may value the collections service that comes with factoring. An established business with good systems may prefer the lower fees and confidentiality of discounting.

What it costs

There are usually two main charges. A service fee, often a percentage of turnover, covers administration and, in factoring, the collections service. A discount charge, similar to interest, is applied to the funds you have drawn. Facilities may also include minimum fees, set-up costs or charges for optional bad debt protection. The right comparison is the total cost of the facility against the value of having the cash sooner.

Who it tends to suit

• Businesses invoicing other businesses on credit terms
• Companies growing faster than their cash flow
• Firms with seasonal peaks or lumpy receipts
• Businesses with payroll to fund ahead of client payment

It tends to suit less well where sales are to consumers, where invoices are raised in stages before work is complete, or where the customer base is very concentrated in a single weak debtor.

Questions worth asking before you commit

• What proportion of my invoices will actually be eligible?
• What are the total charges, including minimums and any extras?
• What is the notice period and are there exit fees?
• Will my customers know, and does that matter to me?
• What personal guarantees or other security are required?

A broker's role is to help you answer these questions before you speak to providers, and to make sure any facility you consider is compared on a like-for-like basis.