7 Things You Need to Know About Invoice Financing for Small Business

Navigating the world of UK business finance can be tricky for small and medium-sized businesses (SMEs).

There's so much to think about, investments and risks to be made, and you're probably wearing far more hats than you'd like. However, understanding what opportunities exist can help you make the most of whatever situation you're in.

For example, look at your cash flow.

If you're looking for ways to improve your cash flow and keep your business growing, invoice financing could be the key to taking your business to the next stage.

In this guide, we'll break down everything you need to know about invoice financing for UK SMEs.

Our goal is to help you understand whether this type of funding is a good fit for your business because trust us when we say it's not for everyone. Divided into seven easy-to-follow essentials.

Let's get into it.

#1 - How Invoice Financing Works

First, the basics.

TLDR: You can take out a loan on any unpaid invoices you're currently sitting on to give you access to the cash in the here and now. You sell your invoices to the company as a kind of collateral for your loan.

This means instead of waiting weeks or even months for clients to pay up, you can get a big chunk of that cash upfront. Here's how it works:

1. You issue an invoice: You conduct business as usual and raise an invoice after providing your products or services.
2. You sell the invoice: You submit the invoice to an invoice financing company.
3. You get an advance: They'll give you a cash advance, usually around 75-95% of the invoice value, typically within 48 hours.
4. Your client pays the invoice: Your client eventually pays the invoice in full directly to the financing company.
5. You get the rest (minus fees): The financing company releases the remaining balance to you minus their fees.

Invoice financing is a lifeline for small businesses because it gives you the cash you've already earned without the frustrating wait. This allows you to invest, scale, and do all the things you need to do, even if you're operating within thin margins and timeframes.

Unlike traditional loans , you don't need perfect credit or a ton of assets to qualify. If you make sales on credit terms (since this is already confirmed income heading your way, which is essentially collateral), this could be a smart way to boost your cash flow.

#2 - Types of Invoice Financing

Invoice financing isn't a one-size-fits-all solution. There are two main flavours: invoice factoring and invoice discounting. Let's break down the difference:

• Invoice Factoring: Think of invoice factoring like outsourcing your accounts receivable. The factoring company buys your invoices and collects the money from your clients. It's a hands-off approach, letting you focus on running your business.
• Invoice Discounting: With invoice discounting, you get an advance on your invoices, but you still handle collecting payments from your clients. Your customers won't know about the financing arrangement, so it's more discreet.

So, which one is right for you? It depends on your priorities:

• Factoring frees up more time but means you'll have less direct contact with your customers regarding payments.
• Discounting means more control over your client relationships but also requires you to have the resources to manage collections effectively.

Think carefully about your business needs and which of these options fits best with your overall workflow!

#3 - Eligibility Criteria for SMEs

Invoice financing can be a game-changer for small businesses, but not everyone qualifies. Lenders operate with some requirements to ensure this type of funding is a good fit. Here's what they typically look for:

• Minimum Turnover: You'll likely need a minimum amount of annual sales. This shows the lender you have enough business coming in to repay the advance.
• Trading History: Lenders prefer to see that you've been in business for a while. This proves you have a track record of success. Extremely new companies may struggle to secure this kind of loan as proof of income is required.
• B2B Customers: Invoice financing usually works best if you sell to other businesses (not directly to consumers). This is because companies tend to have more structured payment processes and use invoices in this sense.

However, don't think of these requirements as a roadblock.

They're there to ensure invoice financing is the right solution for your business. If you don't meet all the criteria, don't worry – there might be other funding options out there that would be a better fit.

#4 - Costs and Fees Associated

Understanding the costs of invoice financing is crucial before you dive in. Here's a breakdown of the typical fees:

• Discounting Charge: This is like an interest rate on the cash advance you get. It's usually a percentage over the Bank of England base rate, ranging from around 1.5% to 5%. The riskier your business seems to the lender, the higher this fee might be.
• Service Fee: This covers the admin work of managing your invoices and chasing payments (if you choose factoring). It's often a percentage of your total turnover, usually between 0.75% and 2.5%.
• Bad Debt Protection Fee: This applies if you opt for 'non-recourse' factoring, where the lender takes on the risk of unpaid invoices. This fee typically ranges from 0.5% to 2% of your turnover.

Of course, these are just general examples of what you can expect, and you'll need to read through your loan provider's policies to understand the facts and figures relevant to you.

The Bottom Line: Invoice financing unlocks cash quickly, but it comes at a cost, as does any funding source. You need to weigh the benefits of improved cash flow against the fees involved. Sometimes, choosing invoice discounting (where you handle your own collections) can help lower costs.

#5 - Impact on Customer Relationships

Perhaps one of the more overlooked aspects of invoice financing is the impact said processes can have on your customers. After all, you're selling your invoice to a financing company, which means they'll know what you're up to.

Invoice financing can affect your customer relationships, depending on the type you choose:

• Disclosed Factoring: Your customers will know that a factoring company is handling your invoices because they'll need to pay the factoring company directly. Some customers might find this a bit of an adjustment.
• Confidential Invoice Discounting: Your customers won't be aware of any financing arrangement. You still collect payments as usual, so there's minimal impact on the customer experience.

If customer relationships are a top priority, confidential discounting might be the better choice.

However, if you choose factoring, open communication with your customers can smooth things over. Be upfront about the process and reassure them that it won't affect the quality of your service.

#6 - Pros and Cons of Invoice Financing

Invoice financing can be a double-edged sword for small businesses, so ensure you're taking the time to see whether it's a good fit for you. Here's a quick breakdown:

Pros

• Fast Cash: Get money from your unpaid invoices immediately instead of waiting for weeks or months. This can be a lifesaver if you need cash to cover payroll, pay suppliers, or jump on a growth opportunity.
• Flexible: The amount of funding you can access increases with your sales. You can choose which bills to fund.

Cons

• Costly: Fees and interest charges can add up. Make sure you factor these costs into your long-term cash flow projections.
• Risk of Debt: It's easy to become overly reliant on invoice financing. If not managed carefully, you could end up in a debt cycle.

The Bottom Line: Invoice financing can be a valuable tool in the right circumstances. But don't get lured in by the quick cash without considering the long-term costs and risks.

#7 - Where to Find Invoice Financing in the UK

Ready to explore your options? Here's where to look:

• Traditional Banks: A good starting point if you have a strong credit history. They might offer lower rates.
• Alternative Lenders: These online lenders often have faster decisions and more flexible requirements. Great if you need money fast.
• Specialist Invoice Finance Companies: These experts live and breathe invoice financing. They can offer valuable advice and tailored solutions.

The most important consideration here is to ensure you're taking the time to choose wisely, which means shopping around. Don't just grab the first offer you come across. Here's what to consider:

• Fees: Compare those discount charges and service fees carefully. Small differences add up over time.
• Customer Support: You want a lender who's responsive and easy to work with, especially if you're new to invoice financing.
• Flexibility: Make sure their terms and limits can grow with your business.

Tip: It's smart to get quotes from several providers to compare offers before making a final decision.

Final Thoughts

Invoice financing can be a powerful tool for improving cash flow and taking your small business to the next level.

By understanding the different types, requirements, costs, and how they could affect your customer relationships, you'll be in a great position to make a smart decision for your business.

Carefully weigh the pros and cons against your own financial goals.

And remember, invoice financing isn't a magic bullet. It's most effective when used strategically.

Don't be afraid to do your homework, compare lenders, and make a plan that supports your long-term growth. If you approach invoice financing thoughtfully, it can help you free up the cash your business needs to thrive.

Ready to get started?

Speak to our experts at Adept Business Finance , and take the first step towards unlocking tailored, flexible funding solutions that propel your business forward.

Discover your finance options today.