Invoice Finance vs Invoice Factoring, What’s The Difference?

Invoice Finance vs Invoice Factoring, What’s The Difference? Let’s remember that a healthy cash flow is a constant challenge for businesses and an absolute essential. Financial instruments like invoice finance and invoice factoring have gained popularity as solutions to this issue. Historically, any form of invoice finance or factoring was taken as a sign of […]

October 2nd, 2023

Invoice Finance vs Invoice Factoring, What’s The Difference?

Let’s remember that a healthy cash flow is a constant challenge for businesses and an absolute essential. Financial instruments like invoice finance and invoice factoring have gained popularity as solutions to this issue.

Historically, any form of invoice finance or factoring was taken as a sign of stress within a business, whilst that was the case once it is absolutely not the case now and represents a great way to better manage cash flow.

However, it’s crucial to understand the specific nuances of these two funding options as they do differ and can often be confused.

What is Invoice Finance?

Invoice finance (also known as Invoice Discounting), also known as accounts receivable financing, is a financing method that enables UK businesses to unlock the value of unpaid invoices.

In this arrangement, a third-party financial institution lends you a percentage of the total invoice value, typically around 80-90%. Importantly, you retain control over your invoices and are responsible for collecting payments from your customers.

Three in five (58%) SMEs are currently waiting on money which is tied up in unpaid invoices, according to research from Barclays

How Does Invoice Finance Work?

Remember that every lender is slightly different so I summarise in broad terms how it works;

Application: Begin by applying for invoice finance with your chosen lender (don’t panic, we do this for you with the best lender for you) providing details about your outstanding invoices across your customer base (this can be worldwide)
Approval: The lender assesses your application, reviews your customers’ creditworthiness, and determines the amount they are willing to advance to you
Advance: Once approved, you receive an advance on the outstanding invoices, often within 24 hours. This advance typically covers a significant portion of the total invoice value and you can usually choose which invoices to finance so you can be selective
Collection: You continue to manage the collection process as you would normally. Once payment is made by your customer it goes to the lender who repay what you borrowed and send you the balance

What is Invoice Factoring?

Invoice factoring, like invoice finance, is a funding solution for businesses seeking to alleviate cash flow challenges.

However, it involves a more comprehensive service where you effectively ‘sell’ your outstanding invoices to a factoring company. This factoring company then takes over the responsibility of collecting payments from your customers, providing immediate cash flow relief in return for relinquishing control over the collection process.

around 50,000 firms close each year due to cash flow problems. If larger businesses paid smaller suppliers sooner, more small firms would have the opportunity to thrive, create new jobs and boost our economy according to Rebuilding Society

How Does Invoice Factoring Work?

Engage: With a UK-based invoice factoring company, they conduct due diligence on your business and your outstanding invoices. No drama there
Purchase: The factor purchases your invoices at a discounted rate, typically around 70-85% of the invoice value which is then paid into your current account, this allows you to access cash quickly, albeit at a reduced amount
Collection: The factor takes charge of collecting payments from your customers, engaging directly with them to obtain payment
Payment: Once the factor successfully collects payments from your customers, they deduct their fees and the discounted amount, returning the remaining funds to you

The costs of having an overdraft are increasing

It sounds almost the same, but there are key differences to be aware of.

Key Differences

Control: With invoice finance you retain control over the collection process, whereas invoice factoring involves the factor taking control of collections. For a small business without a dedicated accounts team this can be beneficial, for other businesses they don’t want their customer to be aware they are factoring and want to retain full control
Customer Relationship: Invoice finance allows you to keep your customers unaware of your financing arrangement, preserving business relationships. Conversely, invoice factoring involves direct communication between the factor and your customers regarding payments. Each to their own as often a larger supplier will be more likely to pay a factoring company on time than they will you, because the factoring company have more clout
Cost: Invoice factoring is often more expensive than invoice finance, given that you’re essentially selling your invoices at a discount and outsourcing the credit collection
Confidentiality: Invoice finance can be kept confidential from your customers, which can be beneficial for maintaining business relationships, while invoice factoring tends to be more transparent to your customers, again each to their own

In Summary

Both invoice finance and invoice factoring offer valuable solutions for improving cash flow. However, they cater to different needs and come with distinct advantages and disadvantages.

Your choice between the two depends on your specific circumstances, the urgency of your cash flow requirements, and your willingness to bear the cost of accessing immediate cash. Bear in mind that facilities like these are often an alternative to overdraft finance (see increased costs above), which can be expensive, has a limit and doesn’t grow with your business. All things these options do do.

These days most of these facilities either link direct to your bookkeeping or invoicing system or allow you to upload invoices for payment, you can be selective about which invoices you finance and with both options retain a large degree of control.

Any questions with which option is right for you, or what your options are then get in touch.

By Dave Farmer

David Farmer

Over 30 years finance experience. Former credit underwriter, founder of Lime Finance Solutions in 2012. Multi Award winning business, featured in Sunday Telegraph, Parliamentary Review, Sky TV and others. Regular contributor to press and business associations. FCA Authorised, ALIBF Qualified. Specialist in Commercial Mortgages, Business Lending, Property and Development Finance.