Before You Use Invoice Finance: Factoring vs Discounting, True Costs and Bad Debt Risk

What invoice finance is and how it works

Invoice finance is a form of asset-based lending where a business uses its unpaid sales invoices as security to obtain immediate cash. Instead of waiting 30, 60 or 90 days for customers to pay, the business sells or pledges its invoices to a finance provider and receives an advance of typically 70 to 90 percent of the invoice value immediately. When the customer pays the invoice, the finance provider releases the remaining balance less their fees.

Invoice finance is most commonly used by businesses with long payment terms — construction, manufacturing, recruitment, and professional services — where the gap between raising an invoice and receiving payment creates cash flow pressure. It is not suitable for businesses that invoice on payment, receive advance payments, or have a very small number of customers where concentration risk is high.

Factoring versus invoice discounting — the key difference

Invoice factoring is a disclosed facility. The finance provider takes over the collection of debts and contacts your customers directly to collect payment. Your customers are aware that you are using a factoring facility. This can affect customer relationships, particularly in industries where factoring carries a negative connotation. The finance provider manages the sales ledger and credit control on your behalf, which can reduce your administrative burden but reduces your control over customer relationships.

Invoice discounting is a confidential facility. You continue to collect debts from customers in the normal way, and the finance provider advances funds against your invoices without contacting your customers. Customers are unaware of the arrangement. You retain control of credit control and customer relationships. Invoice discounting typically requires a larger business with a more established credit control function — minimum turnover requirements are higher and the provider is relying on your ability to collect debts rather than doing it themselves.

Costs and what they actually amount to

Invoice finance costs have two components. The discount charge is interest on the amount advanced, typically expressed as a percentage above base rate applied daily to the outstanding balance. The service fee is charged as a percentage of total turnover funded through the facility, typically 0.5 to 3 percent. For a business with £1 million annual turnover funding all invoices, the service fee alone can amount to £5,000 to £30,000 per year before the discount charge.

Additional fees may include minimum volume fees, concentration charges where a single customer represents more than a specified percentage of the ledger, bad debt protection if credit insurance is included, and early termination fees where the facility is ended before the minimum contract term. Minimum contract terms of 12 to 24 months are common — exiting the facility early can be expensive.

What happens when a customer does not pay

The treatment of bad debts depends on whether the facility includes bad debt protection (also called non-recourse factoring or credit insurance). Without bad debt protection, the business remains liable for the full invoice value if the customer does not pay — the finance provider will reclaim the advance plus fees. With bad debt protection, the finance provider bears the credit risk if the customer becomes insolvent, but protection typically does not cover disputed invoices.

Disputed invoices are a common source of problems with invoice finance. If a customer raises a dispute about the goods or services invoiced, the finance provider will typically remove the disputed invoice from the facility and require repayment of the advance. For businesses with frequent disputes, invoice finance can create cash flow pressure rather than relieving it.

Frequently asked questions

Is invoice finance regulated by the FCA?

Most invoice finance products are not regulated by the FCA. The Financial Guidance and Claims Act 2018 and the Consumer Credit Act 1974 do not generally apply to business-to-business invoice finance. However, if the arrangement involves a regulated credit agreement or the business is a sole trader borrowing as a consumer, FCA regulation may apply. Check with your provider and seek legal advice if uncertain.

Can I use invoice finance alongside a bank overdraft or loan?

You can, but you must disclose all existing finance facilities to the invoice finance provider. Some invoice finance agreements require that the invoices assigned to the facility are not already charged to another lender. Using invoice finance and a bank facility against the same invoices without disclosure constitutes fraud and can trigger immediate termination of both facilities.

What is concentration risk in invoice finance?

Concentration risk arises when a high proportion of your sales ledger is owed by a single customer. Invoice finance providers typically limit the proportion of the facility that can be advanced against invoices from one customer — commonly 25 to 40 percent. If one customer represents 60 percent of your turnover, the effective advance rate against that customer's invoices may be significantly restricted.

How quickly can I access funds through invoice finance?

Once a facility is established, funds can typically be drawn within 24 hours of raising and uploading an invoice. Setting up the facility initially takes longer — typically two to four weeks for the provider to complete due diligence, legal documentation and system integration.

Can I end an invoice finance agreement if it is not working for me?

Most invoice finance agreements have minimum contract terms of 12 to 24 months. Early termination typically requires 90 days notice and may incur early termination fees equivalent to several months of service charges. Review termination provisions carefully before signing and negotiate the notice period and early exit terms before agreeing to a facility.