The Invoice Finance Guide Explaining Receivables Financing
Welcome to our invoice finance guide, which may be better described as a guide to receivables financing. It gives more in-depth, detailed information than our product page.
Firstly, you should visit our invoice finance product page, which gives you what 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.
This guide gives you more detailed information about these products.
Invoice Finance Guide
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 Financing 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, which are 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, while 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:
Learn more about SME invoice finance generally.
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 Products
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. On the other hand, 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, and 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.
The UK Invoice Finance Accessibility Index
The UK Invoice Finance Accessibility Index estimates how much 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 Providers' 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.
Detailed Process Information
See also these Detailed Sales And Operational Process Explanations and details of How To Integrate Invoice Finance With Your Accounting Software.
Understanding 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 businesses of various sizes.
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 decides 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.
If you have been asked to seek alternative facilities by your provider, see our Guidance If Your Provider Withdraws From The Market.
UK Finance Complaints Procedure
UK Finance (which absorbed the ABFA - Asset Based Finance Association) 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.
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.
