What is invoice finance?
Finance for recruitment agencies

What is invoice finance?

Invoice finance is a form of short-term finance secured against unpaid invoices, offered as a line of credit or a cash advance. This type of finance is designed to be used by businesses to improve cash flow. Though upfront funds can be used to purchase equipment, inventory or materials, as well as meet payroll obligations and cover operational expenses.

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What is invoice finance?

Invoice finance is an umbrella term referring to a type of asset-based lending for businesses, with the asset being your unpaid invoices. This can be done by either selling outstanding invoices to an invoice financing company or by using them as security for a line of credit.

Invoice finance can also be called debtor finance. There are two main types of invoice finance: invoice discounting and invoice factoring.

The difference between invoice discounting and invoice factoring

In invoice factoring, a business sells outstanding invoices to a factoring company (or factor). The business can usually access the first 70-85% of the funds for these invoices within 24 hours, known as an advance. The factor then takes responsibility for collecting the debt and managing that risk until the customer pays. Once the debt has been paid, the factor will remit the outstanding amount (called the rebate) minus any factoring fees they have charged for their service (often ranging from 2-5%).

Invoice discounting, on the other hand, uses the business accounts receivables ledger as collateral (or security) for a loan.

The critical difference between discounting and factoring is that, with discounting, the finance company remains hidden in the background - meaning credit and collections remain the responsibility of the business. This means the business keeps control of those vital customer relationships. If a small business has reliable debtors but payment terms that aren't viable for the business, invoice discounting offers a discreet way of managing internal cash flow and maintaining comfortable and friendly debtor relationships.

The pros of invoice finance

Invoice finance can be suitable for businesses of all sizes and industries as long as they raise invoices for goods and services upon completion. Here is an example of the discounting form of invoice finance:

For example, imagine a manufacturing company has a client who has 45-day payment cycles - but the manufacturing company needs to pay its suppliers and workers immediately. They use a third party to borrow the money tied up in the unpaid invoice to pay their costs. The loan to the third party is repaid when the client fulfils payment.

How to get approved for invoice finance

When applying for invoice finance, the lender will want to know about the debtors' risk and the invoices' quality. They also consider ageing (how old the invoices are) and concentration (how many debtors a business has). A ledger full of newer invoices spread over many debtors is more likely to be funded.

The best businesses for invoice finance are ones with a steady flow of invoices and a strong credit history. It's also advantageous if the company has a good relationship with their suppliers. Invoice finance is particularly well-suited for recruitment, manufacturing and transport. Invoice finance may also be an option for newer companies, like small businesses and fintechs, if they meet the proper requirements.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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