Invoice Finance: How Does It Work in the UK?

Every UK business owner knows cash is king, and that cash flow issues can spell doom for even the most promising SMEs

But the reality is, late payments are sometimes unavoidable. And when invoice issues lead to operational issues, many enterprises turn to financial solutions such as invoice finance.

With that in mind, let’s take a closer look at invoice finance and assess invoice factoring and invoice discounting as potential solutions for late business payments.

What is invoice finance?

Invoice finance is a specialist form of lending that lets UK businesses quickly access cash held up in unpaid invoices. In effect, the sales ledger becomes collateral for a flexible loan, and the invoice finance provider releases its value, pending invoice repayments.

Instead of waiting for up to 90 days for late invoices to clear, applicants can immediately use the invoice value at a discount. When the invoice is paid, the business is repaid, less the fees and charges due to the lender.

Who uses invoice finance?

In the UK, invoice finance is a popular financial solution for UK SMEs.

It allows smaller businesses with tighter margins and less financial cushioning to focus on their operational delivery and plans for growth, rather than risk mounting issues from cash flow problems.

What are the types of invoice finance?

The two types of invoice finance are invoice factoring and confidential invoice discounting. Here’s an explanation of how each type of invoice finance works:

How does invoice factoring work?

With an invoice factoring arrangement, the business sells its sales ledger to the lender. The lender then manages the collections process itself and chases overdue payments.

The SME applicant will quickly receive up to 70% to 85%% of the invoice value upfront. The remaining balance payment, less charges such as interest and arrangement fees, is received once the customer’s payment clears.

Invoice factoring is a popular choice for SMEs and newer businesses that lack time or internal resources for collections management.

How does invoice discounting work?

Invoice discounting is ideal for businesses that want to maintain their customer relationships and manage their own sales ledger. It’s also a more confidential service, which means customers never know that third-party finance providers are involved.

As with invoice factoring, the lender advances a percentage of the outstanding invoices, but the SME retains responsibility for payment collection. The advance payment against the invoice gives the SME vital cash flow to run the business and pursue its strategic plans.

This approach is ideal for established SMEs with their own in-house credit control functions.

How does invoice finance work?

Invoice finance processes might differ between lenders, but this is the typical approach.:

1. The business issues an invoice to its customer following its standard processes
2. It then forwards the invoice to its invoice finance provider.
3. The provider advances the business up to 90% of the invoice value as a quick cash payment in just 24-48 hours, supporting the business’s cash flow.
4. The customer pays the issued invoice on the agreed due date.
5. When the customer pays the invoice, the business receives the remaining balance, less the fees due to the finance provider (typically interest, handling fees, and set-up charges).

Why do businesses use invoice finance

There are various benefits to invoice finance, regardless of the kind chosen. These benefits are typically most useful for SMEs and are as follows:

Better cash flow

The invoice finance arrangement lets businesses get paid quicker without needing to wait for extended invoice due dates (and then the risk of chasing overdue payments whilst the cash flow position worsens.

Flexibility

Invoice finance is scalable as the business’s sales ledger grows, offering a degree of flexibility that isn’t typically found with traditional loan products.

Better growth prospects

Growth goals are possible by ensuring the business has the available funds that it needs to invest in equipment, staff, or stock as it services its customers and grows its operation

Possible bad debt protection

Invoice finance can also include optional protection against bad debt, with some services including protection against unpaid invoices. This form of invoice finance with bad debt protection is more expensive, but it does help to safeguard the business as an additional insurance policy.

Speed of access

Invoice finance solutions are generally quicker and easier to set up than traditional business finance, and they don’t require physical security like property to secure. This is because the sales ledger acts as the collateral.