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Invoice Factoring

Invoice Factoring for Small Businesses

Invoice factoring can be a useful way to release capital and help with short-term cash flow, provided you have funds tied up in unpaid invoices. Find out how it works – and how much it costs.

What is invoice factoring?

Invoice factoring is a form of invoice financing where you sell unpaid invoices to a third party in exchange for cash up front, rather than waiting for your customers to pay. It’s a common practice for B2B businesses that need to smooth out short-term cash flow.

It works in a similar way to a secured loan, as the invoice factoring company pays a certain amount up front, often up to 90% of the total outstanding value of your invoices. They will then collect payment from your customers, before paying you the remaining balance minus any fees or interest charged for the loan.

How does invoice factoring work?

The exact steps will vary depending on the provider, but the process generally follows this:

You invoice your customer for the goods or services you provide.
You sell those invoices to a factoring company or lender.
The factoring company advances a percentage of the invoice value.
The factoring company collects payment from your customer.
Once your customers pay, the factoring company sends you the remaining balance minus fees.

» COMPARE: Invoice finance companies

What types of invoice factoring are there?

Invoice factoring comes in a few different forms, depending on where the risk lies and how many invoices are being sold or borrowed against.

Recourse factoring vs non-recourse factoring

Recourse factoring means your business is still responsible for the debt if your customers don’t pay what they’re due. This may mean you have to repay the factoring company, or at least replace the invoice.

Non-recourse factoring shifts the risk on to the factoring company. This means if your customers don’t pay, it’ll be their responsibility to chase the debt or write it off, giving you protection against bad debt and peace of mind when working with customers with unreliable payment histories.

Spot factoring vs whole ledger factoring

Spot factoring, or selective invoice finance, lets you choose individual invoices or a small selection, rather than committing your whole sales ledger. With whole ledger factoring, you agree to factor most or all of your invoices due.

» MORE: Types of business loan

How much does invoice factoring cost?

Generally speaking, you may need to pay anywhere from 1% to 5% of your total invoice value as a fee – but the specifics are likely to depend on the provider, your customers, and the details of your agreement.

What can my business use invoice factoring for?

You might consider invoice factoring as a way to free up working capital for day-to-day cashflow – it’s usually considered as a short-term option rather than a long-term plan. You might use it for:

Wages and salaries
Supplier payments, stock and materials
Operating expenses

What are the pros and cons of invoice factoring?

It’s worth understanding the advantages and disadvantages of using an invoice factoring service before deciding if it’s right for your business:

Pros	Cons
It can offer a useful cashflow boost if your customers are late with payments.	Your customers will know you’ve sold their debt, which can harm customer relationships.
It can be easier to qualify for compared to traditional business loans.	Recourse factoring means you’ll still be responsible if your customers don’t pay.
The invoice factoring company takes responsibility for chasing up payments.	Fees can be relatively high for invoice factoring compared to other financing.
You can pick how many invoices to sell, without needing to offer other security.	Some invoice factoring companies require you to sign a long-term contract.

How to get invoice finance through NerdWallet UK

In three short steps, we can help you find the best invoice finance options for your business – without affecting your credit score.

Tell us about your business: share a few details so we understand your needs.
See your matched lenders: view invoice finance loans from our panel of lenders that your business is most likely to qualify for.
Compare and apply: choose and apply directly with pre-filled details.

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What are the alternatives to invoice factoring?

If invoice factoring doesn’t sound like the best fit for your business, you might want to consider some alternative sources of funding:

Invoice discounting

Another type of invoice financing, this means your business keeps control of customer payments and credit, rather than handing collection over to a third-party as with invoice factoring. This can help preserve customer relationships and reduce costs, but it means you’ll be responsible for ensuring the debt is paid.

Best for: Businesses that want to keep collection in-house.

» MORE: Invoice financing

Asset financing

Asset financing is a form of business funding that you can use to help buy or refinance business assets, like machinery, equipment or vehicles. It lets you use the equipment without having to pay the full cost up front.

Best for: Businesses that want to spread the cost of equipment, machinery or vehicles.

» MORE: Asset financing

Business credit card

Business credit cards work like normal credit cards, and can be useful for short-term cashflow and everyday spending. You can even avoid paying interest if you clear your balance in full every month, improving your business credit score at the same time.

Best for: Businesses that want to manage short-term cash flow and everyday spending.

» COMPARE: Business credit cards

Business loan

Finally, you might opt for a traditional business bank loan, giving you a lump sum that you can repay over an agreed term, plus interest and any fees. You’ll often be able to choose between secured loans, where you put up an asset for collateral, and unsecured loans, which don’t involve any collateral but may require a personal guarantee.

Best for: Businesses that need a lump sum up front.

» COMPARE: Best business loans

Invoice factoring is generally aimed at B2B businesses, but whether or not you qualify will usually depend on how many invoices you have and how reliable your customers are in terms of payment. It can be easier to qualify for invoice factoring than a traditional bank loan, but this varies between providers.

If your customers don’t pay their invoices, the next step depends on whether you’re on recourse or non-recourse factoring:

Non-recourse factoring is often more expensive, but it means the factoring company will take on the loss.
Recourse factoring means your business is responsible for the debt, so you will need to chase the payments from your customers, replace the invoices or repay the money yourself.

Yes, your customers will usually know that a third party has taken control of the invoice, especially as they may have to pay the company directly. This could affect your customer relationships, especially if the factoring company is aggressive when chasing payments. Invoice discounting would be a good alternative if you prefer to keep collection in-house.

Some providers could get the bulk of the amount, up to 90% in some cases, to you within 24 hours of approval.

You might still qualify for invoice factoring with bad credit – in some cases it’s easier to qualify for than a traditional loan. It depends more on the credit profile of your customers, as they’ll be the ones repaying the money owed.

You’re more likely to qualify if your business has a proven track record of invoicing customers, and you may also need to show a minimum turnover. You’re less likely to qualify if you don’t have many customers or have payment terms of more than 90 days.

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