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The Essential Guide to Invoice Factoring

Invoice factoring iconSo you’re a small business owner in need of better cash flow, and are looking for alternative ways to provide fast funds for your growing business?

Invoice Factoring is the solution to your problems.

I’m sure you’ve heard that term before, maybe even considered it, but was unsure if it is the right fit.

Don’t worry.

This guide will explain exactly how your business can benefit from Invoice Factoring, how it works, and introduce you to the top service providers in the UK.

Key Points

  • Invoice Factoring is ideal for fast-growing B2B or B2G startups and small businesses in need of working capital.
  • You sell your client invoices to a Invoice Factoring company, who gives you an initial cash advance totaling 80-95% of your invoice, and handles the invoice settlement for you.
  • You receive the remaining cash installment minus fees when your client settles the invoice in full.


In this guide you will find


What is Invoice Factoring?


Ever found yourself stuck with multiple client invoices with credit terms that mean you have to wait up to 90 days for your clients to pay?

thinking gif

You’re not alone!

Follow in the steps of successful small businesses before you, and utilise Invoice Factoring.

Invoice Factoring is a form of debtor financing where you sell your outstanding invoices to provide immediate funds for your business.

Simply put, you ‘sell’ your client invoices to a third party (a factoring company, also referred to as a ‘factor’), who gives you a 80-95% cash advance of the total invoice value. Once the invoice is settled in full by your client to the factoring company, you receive the remaining amount minus fees.

Here’s the kicker: Invoice Factoring is both a funding and business solution as it solves cash flow issues, while offering your business the potential to make new investments and cover expenses in order to sustain growth.

You are now free to focus on growing your business and covering expenses with funds that you would normally have to wait up to 90 days to collect.

The buyers of your invoices are called Invoice Factors or Invoice Factoring companies. They can either be part of a larger financial institution, independent companies, or multiple individuals via a crowdsourcing platform such as MarketInvoice.

Typically, Invoice Factoring companies will offer services that cover: Invoice Funding and collections assistance.

Invoice Factoring companies provide you with the funds within 24 hours of you raising an invoice to your client. They will also handle the invoice settlement, relieving you of that extra burden.

The benefits of Invoice Factoring are seemingly endless.

Keep on reading and I’ll show you why Invoice Factoring is an increasingly popular choice for small businesses in the UK.


How Does Invoice Factoring Work?


Now that you’re beginning to understand Invoice Factoring, let me break down the whole process for you into 4 simple steps:

  • Application and Due Diligence
  • Debtor Notification
  • Invoice Verification
  • Invoice Funding


Application and Due Diligence

  • You submit an application to an Invoice Factoring company, along with a list of clients, sample invoices, and accounts receivable aging report
  • The Invoice Factoring company reviews your business reports, financial statements, client credit, and that your invoices are free of any other risks
  • The creditworthiness of your clients is especially important because Invoice Factoring companies will typically only finance invoices to clients with a history of good payments


Debtor Notification

  • Once you have been approved by the Invoice Factoring company, they will notify your client to inform them of your new working relationship
  • Your client receives a new address to send invoice payments
  • Some Invoice Factoring companies may offer a confidential Invoice Factoring solution, where your clients won’t know of their involvement with your business


Invoice Verification

  • This is a simple process whereby the Invoice Factoring company verifies your submitted invoice to confirm its accuracy, and that it is free from potential client disputes


Invoice Funding

  • Within 24 hours of raising the invoice to your client, you receive an advance for the factored invoice, which ranges 80-95% of the total invoice value
  • Once your client settles the invoice in full, the Invoice Factoring company deposits the remaining funds to your account, minus fees

Note on Fees:

In general, Invoice Factoring companies will charge a service fee and a discount rate of 0.5-5% of the invoice value. Later on, I’ll cover more about fees associated with invoice factoring so you have all the necessary information.


Invoice Factoring Example

Company X is a small B2B business that needs to free up some funds in order to cover business expenses. It has regular invoices that are sent to clients with credit terms ranging from 30-90 days. This means that they would have to wait up to 30-90 days in order to gain access to those funds.

So Company X decides to apply for Invoice Factoring.

Invoice Factoring company Y agrees to form a partnership with Company X to finance an invoice of £10,000 and a credit term of 30 days, with an advance of 85% (£8,500) and a discount rate of 2% (£200).

After Company X sells its invoices to Invoice Factoring entity Y, it raises the invoice to its client and sends a copy to Invoice Factoring entity Y.

The same day, Company X receives £8,500 and is able to cover its business expenses and focus on business growth.

After 30 days, the client settles the invoice in full with Invoice Factoring company Y, who then deposits the remaining 15% minus £200 (2% discount rate) to Company X.

This means that in this final installment, Company X receives £1,500 – £200 = £1,300.

Yes, it really is that simple.

Now, let’s jump in to find out more about how your small business could use Invoice Factoring.


How can you take advantage of Invoice Factoring?


DId you know that 44% of UK businesses see cash flow as one of their biggest concerns in the immediate 12 months?

It’s no secret that businesses that serve commercial clients and government agencies (B2B and B2G) are often stuck waiting for their invoices to be paid. In turn, they are unable to use the potential funds from their invoices, and their business becomes stagnant.

Similarly, application times for bank loans and overdraft can even be longer than the invoice period itself!

Does all this sound familiar to you?

With Invoice Factoring, you no longer have to wait to cover your business expenses, pay your staff, or delay further investment plans. All you need to do is submit your invoices to a factoring company, and immediately receive funds.

What’s great about Invoice Factoring is that it is not industry-specific.

You heard right!

Anyone can take advantage of Invoice Factoring, as long as you are a B2B or B2G business with immediate working capital needs.

Typically, Invoice Factoring companies have packages that suit the needs of:

  • Startups
  • B2B/B2G businesses with disappointing banking experiences
  • Other small-to-medium enterprises (SMEs).

So far, Invoice Factoring has become commonplace in trucking and shipping companies, as well as recruitment agencies. As a result, there are many specifically tailored packages for freight and staffing factoring.

But don’t let that stop you from taking advantage of Invoice Factoring.

In fact, 83% of Invoice Factoring users are SMEs that come from a wide range of industries.

Admit it, one of the biggest challenges facing small, fast-growing businesses like yours is that you often don’t have the time or monetary resources to chase down clients to pay invoices by their due date.

Not only do you benefit from obtaining upfront funds, but you also receive the advantages of working with Invoice Factoring companies who have excellent in-house resources to perform credit control and collections assistance.

By now you must have a much better understanding of Invoice Factoring and its clear advantages.

But hold on, I’m not quite finished yet!

Later on, I’ll tell you more about the pros (and cons) of Invoice Factoring for small businesses.


What are the Costs and Requirements Involved?


The Invoice Factoring process is relatively simple, because most companies will provide you with a transparent contract and clear lines of communication.

But in order to make an informed decision, you’ll need to know the main costs and components behind Invoice Factoring for your business.

Let’s separate this section into 3 parts:

  1. Invoice Factoring Requirements
  2. Basic Costs
  3. Potential Hidden Fees


Invoice Factoring Requirements

Each Invoice Factoring company has their own specific requirements for application, depending on what they view to be necessary.

However, here is a general list of evidence you will probably be asked to provide:

  • Financial Statements (some will require these be audited), as most Invoice Factoring companies will require a minimum annual turnover
  • List of Clients (B2B/B2G)
  • Credit Reports
  • Business Plan
  • Accounts Receivable Aging Report
  • Tax Returns
  • Information on Assets and Liabilities
  • Sample Invoices that are payable within a certain number of days (typically 90) and are free of contractual issues
  • Proof that your business and clients have not experienced any serious legal or tax problems in recent years

Be sure to contact your potential provider for an accurate list of what they need from you.


Basic Costs

These are the costs you will encounter with every Invoice Factoring company you come across. Knowing what they are can prepare you to effectively choose the best rates and plans that are in line with your needs.

These costs will depend on your industry, invoice value, and business size.


Discount/Factoring Rate

Think of this as an interest rate for the the cash advance you receive, which is comparable to receiving a loan from the Invoice Factoring company.

In general, these are set at 1% to 3% over the UK base interest rate and occur monthly. However, some companies may charge you at a daily or weekly rate.


Origination Fee

Look at this as the onboarding cost for your business to partner with an Invoice Factoring company, open an account, and use its factoring facility.

The Invoice Factoring company charges you this fee to cover the work of taking you on as a client, and to get you set up for a smooth process.


Potential Hidden Fees

These fees may not be paid upfront but may occur over time in your relationship with your Invoice Factoring company. While a few of them are optional fees you can choose as add-on features, the majority of them are linked in with your contract and you need to be prepared in case you encounter them.


Management Fee

A management fee is usually a percentage of your annual turnover, and is charged to you each year of your contract with the Invoice Factoring company.


Contract Exit Fee

Generally, contracts will require a minimum notice period if you intend on discontinuing your relationship with the Invoice Factoring company. These minimum notice periods can be months-long.

If you want to exit the contract earlier, you may have to pay a contract exit fee as a substitute for giving a notice period.


Minimum Usage Fee

You may encounter a minimum usage fee, which dictates how much funding your Invoice Factoring needs to amount to within a certain period of time.

For example, your contract may require you to be funded at least £5,000 per month in invoices. If you don’t meet this, you will be charged a minimum usage fee.


Collections Fee

This is simply to account for the Invoice Factoring company’s efforts to collect past and overdue payments from your clients, on your behalf.


Credit Check Fee

Although most competitive Invoice Factoring companies offer free credit checks as part of their package, some may still charge this fee to cover their work in performing credit checks on your clients.


Bad Debt Protection

This is typically offered as an add-on feature, whereby you can choose to insure yourself against the invoiced client being unable or unwilling to settle the invoice in full.


Pros and Cons of Invoice Factoring


Pros of Invoice Factoring Cons of Invoice Factoring
  • Improves of cash flow and reduces working capital constraints
  • Ultimately receive an amount less than the total invoice value due to discount rate and other fees
  • Provides fast funds to cover business expenses and make new investments
  • Generally, Invoice Factoring is not an option for B2C businesses
  • Receive funds within 24 hours of raising invoice
  • Hidden fees
  • Lower requirements compared to traditional bank loans
  • Risk of damaging your relationship with clients who prefer to communicate directly with you
  • Opportunity for business growth
  • Client credit risks, which can be limited through insurance and credit checks
  • Frees up time by relieving burden of credit control and collections
  • Minimum usage fees and long-term contracts
  • Outsourcing sales ledger management to an efficient company with dedicated resources
  • Client fraud e.g. fake invoicing and misdirected payments, which can be limited through auditing
  • Lower credit risk as your clients are credit checked

If your business has a high amount of ongoing invoices, then you could benefit from Invoice Factoring, as most companies prefer to enter you into a contract.

This is called Contract Factoring, whereby a minimum monthly volume of invoices is required to be factored, or that every invoice to a single client be factored.

The opposite of this is Spot Factoring or Single Invoice Factoring, and it is when you sell a single invoice to the Invoice Factoring company.

It’s not hard to see that Invoice Factoring companies prefer Contract Factoring, as it gives them a higher profit margin, as well as a consistent source of income.

Tip: Consider if your business actually needs the working capital immediately, or whether you can afford to wait to collect the invoice payment at a later date.


To Sum Up…


Everyday, more small businesses like yourself are choosing Invoice Factoring due to its efficiency and simplicity over traditional bank loans.

As a business owner, you know how valuable it is to have that extra time to focus on the needs of your business, while your credit and collections needs are handled by an Invoice Factoring company with full in-house resources.

So, what’s stopping you?

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