How invoice financing can help your business

Cash flow is getting tighter

(Image credit: © Getty Images)

last updated 20 June 2022

Small businesses face a squeeze. Not only are more customers paying their invoices late as the economy slows and cash-flow pressures mount, but securing financing support from the banks is also becoming increasingly difficult. The Federation of Small Businesses (FSB) says 61% of smaller firms were hit by late payments during the first quarter of the year and that just 19% viewed the availability of credit as good – an all-time low.

Still, there may be a way to square the circle. Invoice finance products provide a means to borrow against the value of your outstanding invoices, unlocking funding for cash flow and growth. Invoice finance, which is available from a growing number of finance businesses and specialist intermediaries, is increasing in popularity; around a quarter of those businesses that applied for credit in the first quarter of the year were looking for some form of invoice finance solution, says the FSB.

These products come in different flavours, but the principle of invoice finance is that when a business has an outstanding invoice with a customer, it can sell this debt to a finance firm. Rather than having to wait for payment, the business gets almost the full value of the invoice upfront – the lender takes a percentage as a fee – and the debt is repaid once the customer settles their bills.

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There was a time when invoice finance was considered a last resort. Many small businesses worried about customers’ perceptions, particularly when it comes to “factoring” products, where entire sales ledgers are turned over to the lender to manage. They feared their customers would interpret such arrangements as an indication of financial weakness.

However, a growing number of small business finance experts believe invoice finance has several advantages over more traditional lending. For example, it can often prove more cost-effective than bank finance, as well as quicker to arrange. There is also often no need to put up any collateral, since the invoice itself offers the lender security.

Adaptable financing

In addition, invoice finance is more flexible and more responsive to a business’s changing circumstances. Traditional overdrafts and bank loans are set up at a fixed point in time on the basis of the business’s trading to date. By contrast, invoice finance facilities continuously adapt according to the business’s revenues: if the business is billing more as sales increase, it automatically has access to larger invoice finance facilities.

Thus invoice finance could prove valuable in a volatile business environment where businesses need to react with speed and agility to changing market conditions. It provides a constantly evolving source of funding that changes with its current growth rate.

That said, businesses need to do their research. Some invoice finance providers have been criticised for opaque pricing. They may require small businesses to sign up for contracts of a year or more, often with a monthly subscription fee payable on top of borrowing costs, no matter how much is borrowed. However, the market is increasingly competitive, with a number of new digitally enabled firms offering products that tend to be more straightforward and transparent.

Invoice finance won’t suit all businesses, but for those with significant sums tied up in outstanding customer debts, these arrangements can be an effective way to unlock value. For some firms, the key will be to improve cash flow against a tough economic backdrop, while for others the priority may be to free up funding for growth. But either way, it makes sense to look beyond conventional banking solutions for the best financing options.

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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.