If you’re struggling to get customers to pay their invoices on time and you need to pay your suppliers and improve your cash flow balance, there are options to help you.

Invoice financing is one of those options. It is becoming increasingly popular among small business owners because of its convenience.

In this guide, you’ll find out:

  • What invoice financing is and how it works
  • Types of invoice financing
  • Costs
  • How to use invoice financing
  • Whether invoice financing is a good idea for your business

Read on to learn everything you need to know about invoice financing.

What is invoice financing?

Invoice financing allows businesses to borrow money against unpaid invoices. You use this service when you need the money due from customers before they have paid what they owe you. 

If you need to improve cash flow (the balance of money flowing in and out of your business) or pay suppliers, invoice financing can be a good option. 

How does invoice financing work?

Invoice financing providers buy your unpaid invoices from you. Once your customer pays the invoice, your lender will pay a portion of the total amount to you and take the rest of the money as a service fee. How much they charge depends on the service provider you choose. We’ll explain this in more detail later on. 

Once you have an agreement with an invoice finance provider, you can choose which invoices you want to raise money from.

Here’s how the process works:

  1. Send an invoice to your customer as usual
  2. Send a copy of the invoice to your invoice finance provider
  3. Your provider pays you a cash advance worth an agreed percentage of the invoice’s value
  4. Depending on your agreement, either you or your provider collects the invoice from your customer
  5. You receive the remaining invoice balance minus a fee your provider takes as payment for their service

Types of invoice financing

Below are the types of invoice financing you can choose from:

Invoice factoring

This is when a factoring company will take control of your business’ sales ledger for a specific amount of time, usually 12-24 months. A sales ledger is a document where you record the money you receive from sales, plus what customers owe you. 

During that time, the provider is responsible for collecting your invoices from customers. When your customers pay their invoice, the factoring company will take a percentage as a fee and pay you back the rest of the amount. 

Invoice discounting

In an invoice discounting agreement, you have more flexibility since you can pick and choose which outstanding invoices you want to receive financing on. Invoice discounting also means you’re responsible for making sure your customers pay you on time (known as credit control) and collecting the payment from your customers. 

Asset-based lending

Asset-based funding is where you combine invoice and asset financing (using your company’s assets to get a loan). Choosing this option means that lenders use any business assets you have like property, stock or machinery as collateral. Lenders will use your assets as a safety net in case your customers don’t pay their invoices. In that case, lenders will charge their fee from your assets instead.

This type of financing is usually more suited for larger corporations and may not be relevant to your business. However, as your business grows, it’s good to know that it’s an option. 

What does invoice financing cost?

If you’re thinking about using invoice financing, there are fees you should be aware of. How much you’ll get charged depends on what service you choose (invoice factoring, discounting or asset-based) and what provider you go for. The fees to consider include:

  • Application fee: Not charged by all providers and will vary between industries.
  • Discount charge: Sometimes providers offer a discounted charge for invoices that typically decreases as the invoice value increases. The higher the value of the invoice, the lower the charge. It can range from 0.5% to 5% of the invoice’s value.
  • Administration/credit management fee: The provider will charge for administration costs. A credit management fee will also apply and is typically lower for discounting arrangements since you still collect the invoices from customers yourself. These fees can range from 0.2% for invoice discounting to 2.5% for factoring.

Factors like the size of your business, the sector you operate in and your customers’ creditworthiness also affect these prices.

How to use invoice financing

The good news is that even if you’re a small business with less-than-perfect credit records that prevent you from taking out a business loan, you can still get invoice financing. Invoice financing providers mainly care about your customers’ ability to pay their invoices (their creditworthiness).

  • Start by shopping around and comparing the fees of different invoice financing providers to find the most suitable one for your business.
  • Submit your application (usually on their website) and share details about your invoices to see if you’re eligible for their services. 
  • If you are eligible, the provider will send you a quote telling you your advance rate. Remember to read the terms and conditions carefully and watch out for hidden fees.  
  • Once you agree to the factoring company’s terms, you can raise money from your invoices. You’ll pay the lender’s fee when the balance of the invoice is collected.

Is invoice financing a good idea for small businesses?

Invoice financing can be a good idea if you operate in an industry where long payment terms and late payments are common. It can also be helpful if you have to buy new stock and pay your employees while waiting for your customers to settle their invoices. 

This type of funding is also scalable, which means that the advance payment you receive from your finance provider increases as the value of your invoices does. You may need to negotiate a new arrangement with your provider since they may charge different fees for larger businesses.

One of the downsides of invoice financing is that you’ll lose a chunk of the money you make every month to pay the service fee. As such, invoice financing is only a viable option if your business makes enough profit (funds left after paying all your expenses) to afford to lose that money.

How Countingup can help

Countingup provides real-time insights into your business finances and cash flow management.  Receive profit and loss reports, tax estimates and and create invoices in seconds to keep your business running like clockwork. Find out more here.