What is Invoice Finance? Advantages and Disadvantages

Invoice Finance

Invoice finance provides businesses with the opportunity to access money they are owed by their own customers in advance. In doing so, delays between issuing invoices and collecting payments can be shortened or eliminated entirely.

Where the business issues an invoice, the recipient may have anything from seven to 90 days to pay, sometimes even longer. During this time, the business must continue to make ends meet with its own on-hand capital reserves.

Effectively a financial ‘gap-filler’ for such scenarios, invoice finance allows the business to access its owed capital immediately.

How does invoice financing work?

Invoice finance can be beneficial for any business (or sole trader) for which significant gaps between raising invoices and receiving payments are the norm.

The facility is arranged by a specialist lender, who takes into account the company’s financial status and the professional background of the applicant. Pending invoices are then used to determine how much the business is owed, and the lender issues a loan to cover this outstanding amount.

Over the subsequent weeks or months, the business repays the loan as it collects payments from its customers.

“As the culture of late payment continues to rise here in the UK, the threat that this poses to businesses also grows. Our recent survey results highlight just how vital invoice finance is to businesses,” explained Phil Chesham, head of invoice finance at Time Finance.

“Of the business owners surveyed, 67% reported that an invoice finance facility helps them to pay suppliers, HMRC, employees, and other financial commitments on time. 50% told Time Finance that it helps to manage late payments from customers, and over one-third said it helps them to better combat the current economic challenges such as rising costs and inflation.”

“With late payment debt as high as £200,000 for one in five UK SMEs, invoice finance solutions are as vital as ever, and with the addition of our credit control service here at Time Finance, we can really take the strain away from chasing payments and protect our clients’ customer relationships.”

What Are the Advantages of Invoice Finance?

The potential benefits and cost-effectiveness of invoice finance will always vary significantly from one business to the next.

For those who stand to benefit from an invoice finance agreement, the main advantages of the facility are as follows:

  • Access to Quick Cash: Businesses with plenty of liquid capital always enjoy a competitive advantage over those with limited cash reserves. With invoice finance, the business gains access to the money it is owed right after its invoices are issued.
  • No Assets at Risk: Invoice finance is issued in the form of a specialist unsecured loan, for which the invoices themselves serve as a form of collateral for the facility. This means no physical assets need to be put on the line and subsequently put at risk.
  • Missed or Late Payments: It can also be a useful facility for avoiding (or minimising) the consequences associated with missed or late invoice payments. Where customers pay late, the business can still access the money it is owed in a timely manner.
  • Reputation Protection: Most businesses rely on their customers’ payments to meet their own payment obligations. Invoice financing can make it much easier for businesses to keep their own commitments, protecting both their reputation and their credit status.

What are the disadvantages of invoice finance?

Invoice finance is not suitable for all businesses, and there are downsides to such agreements that must be considered. The most important examples are as follows:

  • Restricted to Business Customers: The only invoices that can be paid early as part of an invoice finance deal are those issued to other businesses. Invoices issued to the public cannot be claimed early on invoice finance.
  • Potential Relationship Strains: With some types of invoice financing (invoice factoring), the lender subsequently takes charge of chasing up the borrower’s customers for payment. Depending on how this is handled, it could result in frayed relationships between the business and its customers.
  • Long-Term Costs: Invoice finance can prove a highly cost-effective and beneficial solution, but it is never offered free of charge. Irrespective of the terms, conditions, and duration of the agreement, it will always result in additional costs for the business.

All the above pros and cons will be discussed in full during your initial consultation, during which your broker will help you determine your suitability and eligibility for invoice finance.

Invoice Finance in Practice

To illustrate how invoice finance works in practice, consider the following example scenario:

  • A small business issues an invoice for £5,000 to a customer with a 30-day payment deadline.
  • The business would like to get this money back as quickly as possible in order to invest it in a new project.
  • An invoice finance agreement is reached for 85% of the value of the invoice, with total borrowing costs of 3%.
  • The business receives a payment of £4,250 from the lender, i.e., 85% of the value of the invoice raised.
  • When the £5,000 invoice is paid, the full £5,000 is transferred directly into the account of the lender.
  • The borrowing costs (£150) are subtracted from the remaining value of the invoice (£750), and the remaining £600 is transferred back to the business.

All invoice finance contracts are bespoke agreements tailored to meet the exact requirements of the business in question. In most instances, the logistics of invoice finance are fairly similar and surprisingly straightforward.

For more information on any of the above or to discuss the potential benefits of invoice finance in more detail, call anytime for an obligation-free consultation.