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Invoice Finance And Receivables Financing Guide

Welcome to our invoice finance guide which may be better described as a guide to receivables financing. It explains all the key information that you need to know if you are considering using this type of business funding or if you are already in an arrangement and are thinking about checking rates or moving providers.

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Definition

It is difficult to find an independent definition of invoice finance online, which can also be referred to as receivables finance, factoring, invoice discounting, sales finance or supply chain finance. Wikipedia redirects you to the term "factoring", and the phrase does not appear in the dictionary. There are plenty of definitions from parties associated with the industry. A good definition is as follows:

"Invoice finance is a way for a business to borrow money based on
amounts due from customers that are businesses."

Invoice Finance

In very simple terms invoice finance means that a business can receive a "prepayment" against its unpaid sales invoices (typically between 70% and 100% of invoice value) so that they don't have to wait for their customers to pay. When the customers do eventually pay, the balance of the invoice, minus charges, is passed onto the business. Sometimes, you may hear these services referred to as "debt purchases".

If the business has a whole sales ledger of outstanding credit invoices, a large tranche of cash can be released in one go when the prepayments against each invoice are combined. Having this kind of financial facility in place can significantly improve the cash flow and working capital position of a business.

Invoice Finance Guide

The rest of this guide will explain the research we have undertaken regarding these products, the way they work and the different types of facilities that are available. It also includes funding levels, qualification criteria, how the pricing works and how to terminate an existing facility.

Funding only is known as an "invoice discounting" facility, whilst funding with a credit control service is called "factoring". There are many variations explained below.

Research Findings

We have undertaken extensive market research regarding receivables finance and some of our key findings, which will be important to anyone considering using these services, are as follows:

• 98% of existing users would recommend invoice finance to other businesses.
• 87% of existing users said using these services enabled their business growth.
• On average companies use these services for just over 5 years.
• Only circa 1% of UK companies use sales finance as there is very little advertising and promotion in the UK.
• 78% of existing users have not checked their pricing, against the market, in over a year. We have found substantial average savings for customers seeking cost reductions.

See our "30-second video guide to invoice finance" below:

Invoice Finance Companies

These services are provided by "invoice finance companies", of which there are over 100 in the UK. Some are specialists handling particular types of products or industry sectors, others provide the full range of services.

There are a growing number of "fintech" providers, who essentially provide their services via online platforms. In some cases, these may provide cheap funding, but that is not always the case in this market and you can often find a small independent company that will quote cheaply as they are keen to acquire your business. Fintechs can be very effective for some businesses, but others provide a more traditional approach of a small independent company that provides a personal service.

The key is to understand exactly what you are looking for and to match the provider accordingly. The service element of any facility is particularly important. It is not always like a mortgage, you just need the money as cheaply as possible. There can be a varying amount of service provided. For example, if the provider is also collecting your sales ledger for you, you will need to ensure that they can provide a high level of service quality as they will have regular direct contact with your customer.

We have undertaken extensive service quality comparison research between different providers. we have found that average service quality ratings (given by existing clients) have ranged from 4 out of 10 up to 9 out of 10, depending upon the provider. We have found a 125% range between the worst and best service providers within the industry. This is a dramatic deviation that should be a concern for anyone thinking of using these services. We can provide guidance about service levels based on the research that we have undertaken.

Also, please see our free guide to understanding factoring agreements.

Bank Owned Or Independent

The providers can also be divided according to the organisations that provide their backing. Those that are bank-owned (by this we tend to mean high street banks) or those that are independent. Even the independents are often owned by very large organisations that you will recognise. Several smaller companies are not part of large groups.

The type of partner that you choose will tend to be driven by the nature of your situation and what you need. For example, we have undertaken a lot of market research into service quality levels among providers. Some of the independents scored very well when rated by their clients for the service that they provided. We found 45% higher satisfaction ratings amongst the clients of independents versus banks. That said, banks also have their place in addressing large lending requirements, that may exceed what many of the independents are able to handle, and banks can often offer some very fine rates based on the scale of their operations.

Specialist Service Providers

There are a number of specialist service providers. These often serve particular niches (such as those wanting to select invoices to get funded) or particular industry segments.

For example, there are specialist financing services for sectors such as:

• Recruitment and temporary staffing agencies
• Construction companies
• Vehicle crash repairers

The Benefits

There can be many benefits from using this kind of service, we will attempt to give a full explanation of the benefits below. Firstly, receiving a cash injection can greatly improve your working capital position. As you raise new invoices, further prepayments are released, such that you are now always waiting for your debtors to pay your sales invoices. This can improve your cash flow by creating more liquidity within your business.

The other benefits depend upon the exact nature of the service that you choose (product variants are discussed below), but they include:

• Improved cash flow. You can use the additional working capital for any purpose, including settling pressing creditors, wages, HMRC or investing in expansion and taking on large orders and projects. You can also approach suppliers for discounts if you can now pay cash for raw materials and supplies.
• Raising funding to assist with acquisitions, mergers, MBOs, MBIs and takeovers.
• Availability of finance to businesses that may not qualify for traditional forms of funding e.g. overdrafts and loans. The nature of these facilities means that the financier is in a safer position (relying on your book debts to recover their advance if required) so that they can take a more liberal view on providing funding.
• Protection against bad debts
• Confidentiality so that customers don't know you are using the service.
• Cost savings from outsourcing your credit control activity (if applicable).
• Help to collect export invoices (again if you select that option).
• Flexibility to dip in and out of using the service - if you choose a selective facility.
• Other additional add-on services such as payroll management and trade finance to pay for imports.
• Electronic access - most providers have some form of electronic access package that allows you to submit invoices, draw down funds and manage your account via an electronic interface.

Common Misconceptions

There are many misconceptions and misunderstandings about these services, often due to a lack of market knowledge. Clients are often unsure about aspects such as the requirements for providing personal guarantees or needing to be homeowners (there are exceptions in both cases). We answered some common misconceptions about invoice funding in our recent article.

Also, some customers consider using a commercial loan as an alternative to invoice financing. This can impact the amount of funding released over time as explained in this article: Comparison Between A Loan And Invoice Finance.

Types Of Product

There are numerous different types of products under this banner term. The phrase is an umbrella term for a wide range of financial product variants that can be broken down in a variety of different ways. In many ways, the term "receivables finance" (or accounts receivables finance, or receivables discounting) is more comprehensive as it includes other ways of charging for transactions e.g. applications for payment that are used in the construction sector, instead of invoices. These products can also be called "accounts receivable loans", despite the fact that they are not technically loans.

Some providers also use proprietary product names, which can complicate matters further.

Factoring Versus Invoice Discounting

There are two broad product options, factoring and invoice discounting - in simple terms, discounting is just the finance, and factoring includes a credit control service. I have written in some detail about the various types of factoring and the types of invoice discounting that are available.

Invoice Discounting vs Factoring Example

When comparing invoice discounting vs factoring examples can be found of both being the most beneficial option for particular cases.

The best solution will not be the same for all businesses. If you need assistance with your credit control factoring is likely to be more beneficial. Whereas businesses with an established credit control function may opt for invoice discounting as they may wish to continue to manage their collections. 

Factoring Finance Despite Credit Issues

Another important benefit when considering factoring vs invoice discounting is that factoring is more readily available than discounting, the criteria for ID are often stricter. The control of the sales ledger that invoice factoring affords the funder means they are more relaxed about proving the finance. It can be offered to businesses with credit issues such as being in a CVA or having prior CCJs.

In brief terms, the options, with both those types of products are:

Non Recourse Or Recourse

Non-recourse means that the service includes bad debt protection, such that the funder will cover a shortfall if an approved customer fails to pay an invoice that falls within a pre-agreed credit limit. Recourse means that the risk is yours, after a specified time period, known as the recourse period, the funding is withdrawn and has to be repaid (often in practice by funding granted against other invoices).

You can achieve a similar situation by having a stand-alone credit insurance policy for your business. However, this can be more expensive as with bad debt protection, the provider is often purchasing one bulk credit insurance policy to cover all of their customers.

Selective / Spot Or Whole Turnover

Selective (also called "Spot" or single invoice finance - SIF) means that you pick and choose which invoices you want to fund against. Often with no obligation to ever use the service again. This can be helpful if you have seasonal cash flow pressures. The alternative is "whole turnover" (sometimes called full turnover or a revolving credit line) where you discount all your transactions. This provides the maximum cash flow benefit.

Selective debtor invoice finance is slightly different in that it allows you to pick and choose the debtors that will be funded, and you’ll be charged for, whilst excluding your remaining debtors from the facility. 

Confidential Or Disclosed

Confidential services are operated such that your customers are unaware of the involvement of the funder. Even if they are providing a credit control service, it is undertaken using the name of your company. The alternative is disclosed, whereby customers are openly aware that there is a funder involved. Allowing confidentiality is considered an additional risk, so it tends to be provided to companies of a better credit standing, whereas a disclosed option can be available to almost any business including those in a CVA or those with a poor credit history such as CCJs.

Add On Services

There are a whole host of additional services that you can add to your facility. These can include:

• Payroll management - outsourcing the task of running your staff payroll.
• Overpayments - if you have a peak cash flow requirement, many funders can provide a temporary overpayment, or cash flow loan, to help you.
• Trade finance - this is additional funding to help you pay for imports.
• Specialist services - there are further tailored products aimed specifically at certain sectors e.g. recruiters or construction firms.
• Islamic invoice finance - there are specialist facilities that do not involve the charging of interest or discount fees.

Qualification Criteria

If you need help getting a receivables financing facility approved, a broker can help you improve your chances of success.

The qualification criteria are driven by the type of service that you are seeking. However, the nature of these services is such that some form of funding can be made available to most businesses, regardless of their financial situation. This type of funding can often offer a lifeline to a business that is in trouble with creditor pressure or preferential creditor arrears e.g. HMRC, VAT, PAYE, NI bills that are due or overdue. The key is that the provision of finance is based on the strength of your debtor book i.e. the simplicity of collection of your invoices combined with the creditworthiness, and spread of risk amongst your debtors. In this way, it is not about the strength of your company, but rather your customers.

The UK Invoice Finance Accessibility Index

The UK Invoice Finance Accessibility Index estimates how much of an appetite UK providers have to offer these services at present. This gives new and existing users an idea of how liberal the UK marketplace is at any point in time. You can see the latest value in the image.

Basic Requirements For Funding

The basic requirement is that you are a company selling to other businesses, on credit terms. It doesn't matter if you are a new startup or an established business. Similarly, size is not a problem, various funders will handle all sizes of companies. There is no minimum turnover or maximum turnover - the same applies to the level of funding required.

If you are a group of companies, the funding can be put in place for all group companies, the holding company and/or its subsidiaries (or sister companies).

Retailers

There are also niche retail finance products that can allow a retailer (who doesn't sell to other businesses on credit terms) to get funding against the volume of sales transacted through their credit card machine.

Different Provider's Criteria

The criteria will also vary between different providers. Some will take a more cautious view than others, not all will handle startups or companies that are in distress. However, there are various providers that will address all niches and all circumstances.

How It Works

In very simple terms this is how it works:

1. You raise your invoices (or applications for payment in the construction sector).
2. You submit them to the financier (either individually, which is normally by uploading an electronic file, or as part of a full sales ledger upload from your accounting software).
3. The financiers make available a percentage of the face value of the new invoices. Funds are normally available within 24 hours of invoice submission.
4. You can choose to draw that money down into your bank account.
5. Either you chase in the payments from the debtors, or a factoring organisation does it for you.
6. The money from the payments ends up in an account controlled by the financier, repaying the advance.
7. The financier makes available the remaining percentage of the invoices, less their charges.

The whole process can be handled in a manner that is totally confidential from your customers, this can be with or without a credit control service being provided in the name and branding of your business.

You can find more details about how invoice finance works here.

See also these Detailed Sales And Operational Process Explanations and details of How To Integrate Invoice Finance With Your Accounting Software.

Pricing

The pricing varies depending on the type of product used and the pricing policy of the provider that you choose.

We have undertaken pricing comparison research, for products such as recourse factoring, and we have identified wide ranges in pricing quoted to the same company. For example, in a recent mystery shopper exercise, we found a pricing variation of 165% between the most expensive and the cheapest quote.

The way the charges are structured is explained in this article: Invoice finance pricing, it also has examples of indicative pricing for various product variations and sizes of business.

In broad terms, the pricing is likely to be as follows:

• For selective (where you choose individual invoices to fund) c. 3 - 5% of the invoice value.
• For whole turnover (where you fund all your invoices - subject to approval by the funder) between 0.25% of turnover and 4% of turnover, with a discount (similar to interest) charged at between 2% and 3.75% over the bank base rate.
• For your whole turnover, a smaller business can alternatively opt for an all-inclusive, bundled fee which starts from £3,000 (+ VAT if applicable) per annum.

Even if you look at those parameters and think you need a better rate, it may still be possible to achieve that as the providers will often pull out all the stops to quote for a deal that they want to win. There are numerous pricing offers available at any time and there is a great deal of competition between providers.

If you have existing quotes or a current facility please see also: Check My Invoice Finance Pricing Against The Market

Funding Levels

The amount of funding provided varies again according to the product, the provider and their opinion of the level of risk that your account presents. Typically 85% is a normal headline rate for core sectors that are often discounted. However, rates can rise to 100% for sectors such as car body repairs and may be higher if other assets are included in the security offered.

Another funder has launched a service whereby they will offer to buy your invoices outright at their full value (less the fee for the service).

In sectors such as construction, 70% is a more typical funding percentage.

The actual level of funds advanced may be subject to additional deductions such as debtor credit limits, prime debtor restrictions and disapprovals due to ageing, to name but a few. When choosing a provider it is very important to understand exactly how they will calculate the level of funding and any restrictions that they will apply. This can be a tricky area on which you should seek advice.

Security

Some funders will require personal guarantees from directors and some require that they are homeowners. However, there are exceptions. See this article: Are Personal Assets Required To Secure Invoice Financing?

Termination

There may be a point at which either you, or your provider decide that you want to terminate the facility, this can be for a variety of reasons, and may or may not be subject to a period of notice - depending upon the circumstances. This process will be governed by the facility agreement that you have entered into. For full details about the termination process please see our: Guide To Invoice Finance Termination.

UK Finance & ABFA Complaints Procedure

The ABFA (Asset Based Finance Association) recently became part of UK Finance, and it is the trade body responsible for many of the providers within this market. However, not all providers are members. Those that are subject to a code of conduct that is backed up by an Ombudsman process through which you can escalate complaints. It may be worth checking if the providers that you are considering are members. Having said that, the level of complaints has been extremely low with only 60 having been escalated to the Ombudsman during the last 4 years. This is another testament to the general levels of satisfaction amongst existing users.

If you have an issue with your provider, we have extensive guidance on our website about how to deal with complaints about invoice finance.

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If you need more help please call Sean on 03330 113622 but we hope you have found what you need in our free guide to invoice finance.