Invoice factoring provides working capital finance by releasing the capital that’s tied up in your unpaid invoices and you will outsource your credit control to the factoring company who will help with collecting payment too. This differs to invoice discounting which is a funds-only solution and you retain responsibility for credit control.
Invoice factoring is a funding solution for SMEs that are selling business-to-business on credit terms; rather than waiting 30, 60 or 90 days for your customer to pay, the funds can be in your bank account within 24 hours of the invoice being raised.
It can also be known as invoice finance, sales ledger finance or receivables finance.
How Does it Work?
Invoice factoring is best suited to SMEs that are selling business-to-business on credit terms and where you issue invoices to your customers in arrears.
You should complete the job as usual and send the invoice to your customer. At this point, you would notify your invoice factoring company and they would advance a percentage of the invoice value e.g. 85% within 24 hours.
When the invoice is due for payment, the factoring company will contact your customer to ask for payment. Your customer will pay into a bank account which is operated by the factoring company.
Once your customer has paid the invoice, the initial advance will be repaid and the invoice factoring company will take their fees, then the remaining balance e.g. 15% will be made available to you.
How much does it cost?
There are two main fees with invoice factoring: the service fee and the discount rate.
The service fee is charged as a percentage e.g. 1% of every invoice that you assign to an invoice factoring company. The rate itself is linked to several factors but one of the major ones is turnover; generally, higher turnover will command a lower service fee. On a like for like basis, invoice factoring will usually attract a higher service fee than invoice discounting as there’s more work involved for the invoice finance company.
The discount rate should be viewed as an interest rate and it is charged based on the amount borrowed. For example, 3% over base rate on the balance. Again, the rate itself is linked to several risk associated factors.
There may be other fees associated with setting an invoice factoring facility up such as the arrangement fee, which is usually a percentage of the funding limit, and a survey or audit fee for the lender’s due diligence.