Invoice finance explained - how does it work? | Swoop UK (2024)

Invoice is suitable for many small or medium-sized companies with B2B customers as it lets businesses get paid faster, sometimes within 24 hours, as they receive a large percentage of each invoice as soon as it is raised, using their unpaid invoices as the basis for a loan or an advance.

It is a funding option for businesses that have a minimum of £30,000 annual turnover and get paid by invoice in 14 days or more. Depending on the type of product or service a company sells, and the payment terms of their invoicing, Swoop’s network of UK invoice finance lenders can provide up to 95% of invoice value.

This type of borrowing can be particularly useful for businesses that have few assets to offer as collateral for a bank loan. Their unpaid invoices are the collateral. There is usually no need for additional security.

With invoice finance, the lender utilises unpaid invoices as the security for funding, giving you fast access to part of the invoice’s value. Payment is usually made within 48 hours of submitting your invoice. The sum received may vary from 75% to 95% of the invoice value. You retain control of your sales ledger and are still responsible for chasing your customers for payment.

Customers post their payments into a trust account controlled by the invoice financing company, but with the appearance of an account controlled by you. The customer assumes they are paying you, not the lender. Once the loan is repaid, and the lender deducts interest and fees, the balance is transferred to your bank account. In most cases, the customer will never know you used the invoice as security for a loan.

Invoice financing can be used across your whole sales ledger, or you can choose the customers and the invoices you want to use for a loan (this is called selective receivables financing).

In simple terms, invoice financing functions in the same way as a revolving credit line or a series of short-term bank loans. However, unlike those types of lending, with invoice financing, the borrower usually has no need to provide assets as collateral, nor are the owners or directors required to supply a personal guarantee.

Invoice finance in the UK falls into two broad sub-types:

• Invoice financing(or invoice discounting)
• Invoice factoring(or account receivables financing)
• Selective invoice finance(choosing to finance specific customer accounts)

Within these sub-types, there are further differences, such as ‘selective receivables financing’. These variances can affect the percentage of the sum of each invoice that is immediately provided, and the fees and interest charged.

However, the main difference between the two types of finance is who collects on the unpaid invoices. With invoice financing, the company borrows against their unpaid bills. They retain control of their sales ledger and are responsible for collecting unpaid sums. With invoice factoring, the company sells their sales ledger to a third-party lender (the factor), who collects the unpaid sums. Invoice financing is confidential. The company’s customers will usually remain unaware that the company is borrowing against their invoices. With invoice factoring, the company’s customers will usually know.

Invoice financing leaves you in control of your sales ledger and responsible for chasing your customers for payment. This creates less administration for the lender than invoice factoring. Accordingly, the costs are lower.

UK Invoice financing companies earn money from each transaction in two ways: by charging interest, and by charging a credit management fee. The first covers the time-use of their money, the latter covers their administration costs. Typical interest rates range from 1.5% to 3% over Bank of England base rate and are calculated daily. Credit management fees typically vary from 0.25% to 0.5% of turnover. Invoice financing costs are similar to many traditional forms of business funding, such as overdrafts and bank loans.

Swoop works with a wide range of invoice financing companies. Terms and costs can vary.Register with usto receive a quote for costs and services tailored to your business needs.

A wholesaler sends an invoice for £10,000 to a customer. They usually take 60 days to pay the bill. This locks up the value of the invoice for two months and slows down the wholesaler’s cashflow.

However, the wholesaler has an agreement with an invoice financing company. They will lend 80% of the value of the invoice as soon as it is raised. The wholesaler submits a duplicate of the invoice to the lender and they send £8,000 (80%) to the wholesaler’s bank account. This is called the ‘pre-payment percentage’.

60 days later, the customer pays £10,000 into a trust account controlled by the lender. As this is confidential invoice-financing, the customer assumes they are making payment direct to the wholesaler. They remain unaware of the lender’s role. The lender recoups the loan of £8,000 and after deducing fees and interest, they send the balance to the wholesaler’s bank account.

This example could look like this:

Invoice value: £10,000

Loan sum: £8,000

Balance outstanding: £2,000

Sum paid by customer: £10,000

Loan recouped: £8,000

Fees and interest: £300

Balance transferred to wholesaler: £1,700

Yes. If your annual turnover is a minimum of £30,000 and you get paid by invoice on 14 days terms or more, invoice financing could work for you. Key considerations for approval include:

• Minimum turnover
• Your customers are businesses, not consumers (B2B)
• Invoice terms that fit the lender’s criteria
• Good customer payments history
• Most recent set of accounts

Although they both provide early payment of outstanding bills, invoice financing and invoice factoring are not the same. Invoice financing uses a company’s invoices as security for a loan. Factoring agents (the factor), buy a company’s invoices. They take control of the sales ledger and provide an advance against each invoice.

Factors typically advance 75% to 95% of invoice value. After deducting their fees, the factor transfers the remaining balance to the company when the invoice is paid by the customer.

The key difference is that in factoring, the factor is responsible for chasing the company’s customers for payment. This means factoring is not confidential. Customers will be aware that the factor has taken control of the company’s sales ledger. This could be a problem for businesses in debt-sensitive industries, such as recruitment or law.

Invoice financing and invoice factoring have different cost structures. Invoice financing companies charge interest on the loan, plus an administration fee. Factoring agents charge something called the ‘factor rate’. This is a hybrid calculation, and it works out as a percentage of every invoice and a ‘time-charge’ that reflects the length of time that credit is extended. Because factoring agents take over the company’s sales ledger and assume responsibility for chasing customers for payment, their administration costs are higher than those for invoice financing. This means factoring usually costs more than invoice financing.

Invoice financing costs:

Invoice financing costs are straightforward. Borrowers are charged interest and credit management fees. Typical interest rates range from 1.5% to 3% over Bank of England base rate and are calculated daily. Credit management fees typically vary from 0.25% to 0.5% of turnover. Interest and fees are usually billed on a monthly cycle. There may also be other costs – such as an origination fee for processing the loan.

Invoice financing companies will consider risk when calculating the interest rate and their management fee. The credit-worthiness of your customers, the length of time they take to pay, and your business’ credit history are key parameters in this calculation.

Invoice factoring costs:

Invoice factoring costs are called the factor rate. It is based on the level of risk and the volume of invoices. Factors like low risk, (your customers are unlikely to default on payment), and high volume, (the cash value of factored invoices is high).

• The lower the risk and the greater the volume, the lower the factoring costs
• The higher the risk, and the lower the volume, the higher the invoice factoring costs.

Factors consider the following when calculating your factor rate:

• The cash value of the invoices you will be factoring:the more money being processed, the lower the rate. This is probably the biggest determiner of your factor rate.
• The size of each invoice:it takes the same amount of work to collect a small invoice as a large one. Therefore, it pays to have fewer large invoices rather than lots of small ones.
• The industry you work in: the factor will assess the track record of your industry when determining your factor rate. The more risk, the higher the factor rate.
• How reliable are your clients: clients who have a track record of paying on time drive a lower factor rate than those with a poor credit history.
• Your business credit rating, history and turnover: Some factors in the UK will want you to have been trading for at least one year. This can be a problem for startups. They may also expect you to have a minimum annual turnover, for example, £30,000.

Factor rates can vary from 0.5% to 5% of invoice value. This is applied as a fee and for set time – for example, 3% for the first 30 days of an advance against the invoice. The factor will also charge a further percentage if the advance is outstanding beyond this initial period – for example, 0.5% for each 10 days after the first 30 days. Some factors set a ‘flat rate’ that does not have an escalating charge rate. The cost is the same, even if the invoice takes more than 30 days for payment.

Blockchainis a digital system of recording information using powerful cryptography. It is essentially a digital ledger of transactions that is shared across a network of computers linked by the blockchain. Shared monitoring ensures transparency and eliminates fraud. Cryptocurrencies such as Bitcoin and Ethereum use blockchain technology to function as digital currencies that exist outside established (‘flat’) national currencies such as USD and GBP.

A small but growing number of fintech businesses are offering or developing blockchain systems for use in invoice finance. Although the goal is still the same – early payment of unpaid invoices – the primary advantages of blockchain over traditional invoice finance methods appear to be greater transparency, which lowers risk, and faster transactions, which increases volumes. The combination of reduced risk and greater volumes can lower costs to companies and invoice finance providers alike. Increased productivity and growth are the net result.

Many of the new blockchain players offer the ability to switch funds from fiat to cryptocurrency and back again. This has the potential to reduce forex costs for businesses that operate across international boundaries.

The explosive growth of invoice finance has seen a matching rise in invoice finance fraud.

Invoice finance fraud falls into two categories: ‘Fresh air invoicing’ and ‘Fake invoicing’. In the first instance, a company that has not yet completed an order raises an invoice to receive an advance from their lender. The business is seeking payment before their goods or services have been supplied. They are trying to get paid early. Sometimes this activity is called ‘pre-billing’, but this fraud is usually used to conceal an inability to fund an order. The business does not have the money to complete and deliver.

With fake invoicing, the fraud is more blatant. The business raises an invoice that is totally fictitious. In this case, the funds received from the invoice financing company are usually moved to a location where the lender cannot reclaim them, and the business that created the fake invoice quickly falls into insolvency.

Invoice fraud is a criminal act that can lead to prosecution.

A company has an order from a customer with a value of £100,000. To fulfil the order, the company needs materials costing £50,000. The company will have to wait three months before receiving payment from their customer. To prevent a drain on cashflow, the company obtains an invoice from the materials supplier, which they submit to a lender. The finance company provides a loan of £50k, allowing the company to obtain the materials it needs.

Once the order has been completed and delivered, the customer pays £100,000 into a trust account controlled by the lender but appearing to be controlled by the company. The lender recoups their loan, plus interest and fees, then transfers the balance of the payment to the company.

This example of account payable financing could look like this:

Order value: £100,000

Materials cost: £50,000

Loan value: £50,000

Materials purchased.

Order delivered.

Payment from customer: £100,000

Loan recoupment: £50,000

Interest and fees: £2,500

Balance transferred to company: £47,500

Invoice financing and invoice factoring have their unique pros and cons:

• Invoice factoring is more expensive than invoice financing
• Invoice financing leaves the company in control of the sales ledger, but this also means they must still spend time chasing customers for payment
• Invoice factoring sells invoices to the factor, who then assumes responsibility for pursuing customers for payment
• Invoice financing is confidential. Customers may never know invoices are being used as collateral for borrowing
• Invoice factoring is not confidential. Customers will be aware that the company has sold control of the sales ledger
• Invoice factoring may not be available to most startups
• Invoice factoring and invoice financing can release up to 95% of invoice value in less than 48 hours.

Probably. Invoice financing approvals are largely based on the financial strength of your customers, their payment history, and the terms of your invoices. Your personal credit should not be a factor. However, as with many other forms of business borrowing, the lender will usually ask to see recent accounts and perhaps your business bank statements. They must be confident that your business is not in difficulty. For sole traders and some partnerships, lenders may also review your personal credit. Company credit ratings are more relevant for limited companies.

Swoop works with UK invoice finance companies that specialise in borrowers with poor credit. Even if you’ve been turned down for other types of loan, it may still be possible to obtain funds using your invoices as security.Register with usto discuss your funding needs.

Yes. Unlike factoring, where a business sells its invoices to a factoring agent for a discount, invoice finance uses a company’s invoices as security for borrowing. Factoring agents provide an advance. Invoice financing companies provide loans.

The key difference between business loans made with invoice financing and loans obtained using assets as collateral, (as in a standard bank loan or asset finance), is the lender recoups the loan and their fees at source. They do not wait for the borrower to pay them. They take repayment direct from the borrower’s customer.

Payment delays in the construction industry are common. Waiting three or four months for payment of an invoice is typical. Wait times can be even longer on large-scale or government-funded projects. To ease the burden this would place on cashflow, many small and medium-sized construction companies rely on invoice finance to pay workers, buy materials, and meet deadlines.

Specialist invoice finance providers offering unique invoice financing and invoice factoring programmes for the construction industry can be found within the Swoop network. These bespoke construction invoice finance options account for the ‘stage-payment’ method of many construction contracts and the enhanced risks and lengthy payment times endemic to the UK construction industry.

Recruitment is a people business and a recruitment company’s people are typically their best asset. However, personnel cannot be used as security for a business loan. Without sufficient hard assets as collateral, small and medium-sized recruitment companies may struggle to obtain traditional business funding. Recruitment invoice finance can fill the gap.

Specialist providers offer invoice financing and invoice factoring for recruiters that eliminate the lengthy wait between raising invoices and client payments. Customised to accommodate the sensitivities of the HR sector, transaction agreements can be kept confidential to avoid alerting clientele to the recruiter’s need for funding.

For businesses that need to boost their cashflow, invoice finance can be an ideal funding solution: no need for hard assets, no personal guarantees, get up to 95% of your invoice value as soon as you raise it, and eliminate months of waiting for customers to pay.

If you are seeking a flexible and scalable solution to your cashflow problems, and the higher costs associated with invoice finance are acceptable to you, invoice finance is worth considering.

Keep in mind that invoice finance is designed to defeat cash flow issues, it is not a replacement for revenue. While loans and overdrafts can give you a cash injection when business is slow, invoice finance relies on your business successfully winning sales and raising invoices. If you fail to secure new sales, invoice finance will not solve underlying problems. Low revenue is always low revenue. Invoice finance alone cannot get you through a ‘dry patch’.

Swoop makes the application process simple. Call us orapply onlinenow to receive quotes for invoice finance tailored to the specific demands of your business.

Eliminate the burden of slow cashflow. Rapidly release the funds you’re owed.