How invoice finance works: a plain-English guide for UK businesses

1. You deliver goods or services and raise an invoice to your business customer as normal.
2. You upload the invoice, or your whole sales ledger, to the finance provider.
3. The provider advances an agreed percentage of the invoice value, often somewhere between 80% and 90%, into your bank account.
4. Your customer pays the invoice, usually into a bank account controlled by the provider.
5. The provider releases the remaining balance to you, less its fees.

Because the facility is linked to your sales ledger, the amount you can draw tends to grow as your invoicing grows. That is the main difference from a loan, which is a fixed sum agreed at the start.

• Invoice factoring: the provider runs your sales ledger and chases payment. Your customers will know you are using a finance provider. Useful if you do not have an in-house credit-control team.
• Invoice discounting: you keep control of collections and customer relationships, and the arrangement can often be confidential. Providers usually want to see stronger turnover and good credit-control processes.
• Selective or single invoice finance: you choose individual invoices to fund, rather than committing your whole ledger. Handy for occasional large invoices, though often more expensive per invoice.
• Construction and contract finance: specialist versions for sectors using applications for payment or stage billing, where standard facilities may not work.

We cover the first two in more detail in our guide to factoring vs invoice discounting.

With a recourse facility, you carry the risk if a customer does not pay. If an invoice goes unpaid beyond an agreed period, you will need to repay the advance or replace the invoice with another one.

With a non-recourse facility, the provider includes some form of bad debt protection, so it absorbs the loss if an approved customer becomes insolvent. This costs more and usually comes with credit limits on each customer. Read the small print carefully: non-recourse cover often applies only to insolvency, not to disputes over the quality of your work.

Pricing varies by provider and by the quality of your debtor book, but most facilities combine a few elements:

• A service fee, usually a percentage of your invoiced turnover or a fixed monthly amount.
• A discount charge on the money you actually draw, which works much like interest and is often priced over a base rate.
• Possible extras such as set-up fees, audit fees, bad debt protection premiums, same-day payment charges or minimum monthly fees.
• Exit or termination fees if you leave during a minimum contract term.

Compare the total expected cost over a year rather than a single headline figure. A low discount charge can be offset by a high minimum fee if your usage turns out lower than planned.

• Who your customers are: providers are lending against their ability to pay, so the creditworthiness and spread of your debtors matters a great deal.
• Concentration: if one customer makes up a large share of your ledger, providers may cap how much they will fund against that customer.
• Invoice quality: clear, undisputed invoices for completed work are easier to fund than stage payments, retentions or contra accounts.
• Your turnover and trading history: most providers want to see a settled trading record, and confidential discounting usually needs a longer one.
• Your credit-control processes and any history of disputes or bad debts.

The first thing we ask for is an aged debtor report. It shows at a glance who owes you money, how late they typically pay and whether one customer dominates the ledger, which is usually what decides whether a provider can help and how much it will advance.

The advantages are straightforward. Funding tracks your sales, so it can support growth without a new application each time. It does not usually require property as security. And factoring can take credit control off your plate.

The drawbacks are worth weighing too. Contracts can have minimum terms, notice periods and fees that make leaving expensive. Factoring puts a third party in contact with your customers. And the facility shrinks if your sales fall, just when you might need cash most. Directors are often asked for a personal guarantee or an indemnity covering certain risks such as fraud or disputes.

It tends to suit businesses that invoice other businesses on credit terms, have a reasonable spread of reliable customers and want cash flow that scales with turnover. Recruitment, manufacturing, wholesale, logistics and business services are common users.

It is less suitable for businesses selling mainly to consumers, those with heavily disputed or staged invoices, or those that only need a one-off sum, where a short-term loan may be simpler. If your customers already pay promptly, tighter credit control, or using your statutory right to charge interest on late commercial payments, may solve the problem at no cost.

Welcome Finance is a commercial finance broker for UK limited companies, LLPs and partnerships of four or more partners. We compare invoice finance providers alongside other options and explain the costs and contract terms before you commit. Check your eligibility in 60 seconds; it will not affect your credit score, and providers only run their own checks if you choose to go ahead.