Cash is an essential part of any business. It is needed to pay suppliers, employees, utility providers and landlords, buy raw materials and take advantage of opportunities to grow. Without a healthy level of cash in the business, it can become difficult to operate effectively and even lead to insolvency.

Unfortunately, cash-flow shortages do not discriminate. As well as struggling businesses, they can also affect profitable firms with full order books. For that reason, it's essential businesses have a plan in place to solve cash-flow issues if and when they arise.  

The role of invoice finance

One of the most important lessons to learn when trying to maintain a healthy level of cash-flow is that the speed you collect payments from your customers is key. With payment terms of 30, 60 and even 90 days in some sectors and late payments common across all industries, it's often easier said than done. That's where invoice finance can help.

Invoice finance is the collective term for factoring and invoice discounting, two types of short-term finance which allow businesses to unlock the cash tied up in their invoices within as little as 24 hours of their issue. That's done by effectively ‘selling' the invoice to a third-party finance provider. They provide a cash advance of between 70-90 percent of the invoice's value upfront. Once the customer pays the invoice, you receive the balance minus the finance provider's fee.

With record levels of invoice finance lending to UK businesses in 2017, this could be a viable solution for your business. That's why it's important you understand the key differences between the products available.  

Invoice factoring

Invoice factoring is generally considered to be a more appropriate product for smaller businesses because it includes additional service elements such as credit control and payment collections. These can be extremely valuable for smaller businesses that do not have the relevant expertise in-house. Taking control of these functions also reduces the risk for the finance provider and allows it to work with businesses with lower revenues, shorter trading histories and less established customers.

How does it work?

Just like any invoice finance agreement, invoice factoring allows businesses to raise money by selling invoices to a finance provider at a discount. Once a business has agreed terms with the finance provider, the factor becomes responsible for managing the business's sales ledger for the term of the factoring contract.

In return, the factor provides an upfront advance when your business sends an invoice to a customer. When it's time for the invoice to be paid, the factor collects the payment from the customer and hands over the balance to your business, minus its fees. Typically, customer payments are paid into a bank account that's controlled by the factor, so your customers will be aware that a finance arrangement is in place.

What are the advantages of invoice factoring?

  • Cash in your hand in as little as 24 hours;
  • Startups and small businesses can apply;
  • The factor is concerned with the customer's ability to pay the invoice, so the credit history of the business or the business owner is less of an issue;
  • You benefit from the expertise of a specialist credit control department;
  • You no longer have to spend time chasing customer payments;
  • In many cases, no security is required apart from the invoice itself.

Invoice discounting

Although very similar to invoice factoring, there are some important differences in the way invoice discounting agreements works. Invoice discounting does not provide the same level of additional services as factoring. That makes it's the cheaper of the two products and also means it's better suited to larger companies with higher levels of turnover and an established debtor book.

How does it work?

The main difference is that in an invoice discounting facility, the customer will not usually know you are working with a third-party finance provider. That's because you retain control of your sales ledger and are responsible for collecting payments and sending out payment reminders. Once the invoice provider has released the initial advance, you are responsible for collecting the balance from the customer. That allows you to retain positive relationships with your customers and maintain your high levels of customer service.

From the finance provider's perspective, invoice discounting represents a greater risk because it does not have control over the credit control process and the collection of payments. For that reason, invoice discounting providers tend to work with larger businesses that have established customers and a longer trading history.

What are the advantages of invoice discounting?

  • There's no impact on business relations;
  • You retain full control over the business's receivables;
  • The agreement can remain confidential;
  • It costs less which reduces the impact on profit margins;
  • Invoice discounting providers will often accept businesses that have been refused finance by other lenders such as the banks.

Could invoice finance could be an effective way to boost the working capital in your business? Business Expert allows you to compare the UK's leading invoice finance providers to help you find the best deal.