Bank Loans or Invoice Financing? Which is better?

October 31, 2016

Why would you pick Invoice Financing over a Bank loan?

A loan is credit, usually in the form of cash, that you borrow and repay over an agreed length of time. As well as repaying the amount you’ve borrowed, you normally have to pay interest on a loan. The amount will depend on:

  • how long you need the loan for;
  • how much you borrow;
  • whether the loan is ‘secured’ – eg if you own your home and agree to transfer; ownership to the loan provider if you don’t keep up your payments;
  • other factors, like the Bank of England base rate.

Invoice discounting is mostly aimed at larger businesses (typically above £2m annual turnover) with well-established systems and procedures in credit control and sales ledger management.

The invoice financier essentially lends the business money against its unpaid invoices, being an agreed percentage of the total value of the invoices. As the customers pay their invoices, the money goes to the invoice financier, reducing the amount owed and allowing more borrowing on the invoices from new sales, again up to the percentage previously agreed.

There is a balance to be struck for any company considering using invoice factoring or discounting between the value of selling invoices and waiting for however long it takes for those invoices to be settled under normal circumstances.

Advantages of Invoice Financing

  • The various forms of invoice financing allow businesses to free up capital tied up in invoices with long remittance terms.
  • It can be arranged confidentially so customers won’t know what the business is borrowing against their invoices.
  • Once an invoice is raised, potentially up to 90% of the invoice value could be available with 24-48 hours; funds are made available quicker when compared with bank loans.
  • Better cash flow gives increased bargaining power with suppliers and less need to concede discounts to customers.
  • Removal of cash flow worries allows more time to be spent developing and improving the business.
  • Comparatively, it offers a more cost-effective facility.

Disadvantages of invoice financing

Some disadvantages of invoice financing are that:

  • You’ll lose profit from orders or services that you provide.
  • Invoice financiers will usually only buy commercial invoices – if you sell to the public you might not be eligible.
  • It may affect your ability to get other funding, as you won’t have ‘book debts’ available as security.
  • Your customers may prefer to deal with you directly.
  • It may affect what your customers think of you if the invoice financier deals with them badly.
  • Once a business enters into an invoice discounting arrangement it can be difficult to leave as the business becomes reliant on the improved cash flow.

Businesses best suited to Invoice Financing

  • Invoice financing is suitable for most business in the manufacturing, business services and distributive trade sectors in the UK, selling goods and services to other businesses on normal credit terms and who are seeking short term borrowing aimed at specifically improving its working capital and cash flow position.
  • The key point is that no business is excluded, even those making trade losses since the invoice financing company’s security is primarily its customers (through the invoices). Invoice financing facilities are therefore available to sole traders, partnerships, limited companies, plc’s and new start–ups.

What is factoring?

Factoring’ – also known as ‘debt factoring’ – usually involves an invoice financier managing your sales ledger and collecting money owed by your customers themselves. This means your customers will know you’re using invoice finance.

  • When you raise an invoice, the invoice financier will buy the debt owed to you by your customer.
  • They make a percentage of the cost (usually around 85%) available to you upfront.
  • They then collect the full amount directly from your customer.
  • Once they’ve received the money from your customer, they make the remaining balance available to you.
  • You’ll have to pay them a discount charge (interest) and fees – the amount depends on which invoice financier you use.

Invoice discounting is ideal for those businesses eager to expand, but need a little help with the funds. Many banks, financial institutions and invoice financiers offer a range of invoice financing products making invoice financing potentially an attractive alternative form of funding for businesses.

This article has been produced for general information purposes and further advice should be sought from a professional advisor. Please contact the Banking team at Cleaver Fulton Rankin for further advice or information.