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Business Finance Series – What is Invoice Finance? – Part 5

I started a blog series several weeks ago talking all about invoice finance and this is the fifth in the series.

As you might imagine, there are a variety of different options available when it comes to invoice finance. They all work in different ways and have different qualifying criteria, but essentially the main types of invoice finance are as follows:

  • Factoring
  • Spot factoring
  • Invoice discounting
  • Selective invoice discounting

In this week’s blog I continue the series by looking at invoice discounting. Because invoice discounting is a big subject, I will cover it over the next two blogs.

Invoice Discounting
Invoice discounting is similar to factoring, with one crucial difference.

In a similar way to factoring, you have a contract with the funder, there is both an interest charge and a service fee, funds are released against the value of the invoice, and up to 95% of the value of the invoice is available, with the balance of the invoice less the funders costs being paid to you once the invoice has been paid by your customer.

In all these respects factoring and invoice discounting are very similar. The big difference between factoring and invoice discounting is that invoice discounting is confidential.

What do I mean?

Put simply, your customers don’t know you are raising finance against their invoices. In other words, you retain the credit control function within your business rather than the credit control function being dealt with by the lender, as is the case with factoring.

Because invoice discounting is entirely confidential, it means your customers don’t know you are raising funds against their invoices, (which is a very important point for some business owners). Therefore, your lender makes no contact with your customers and as far as your customers are concerned, they are paying you directly, although I will explain exactly how payment works a little later in the blog.

The result is you can continue to nurture and develop your ongoing relationships with your customers without them being contacted by a third party, namely the lender.

Because you remain in control of your sales ledger, lenders tend to apply stricter criteria to an application for invoice discounting than they do to an application for factoring.

The main differences between invoice discounting and factoring could be summarised as follows:

1. Invoice discounting is suitable for established medium and large companies as well as corporates with a stable trading history. Factoring on the other hand is suitable for start-ups and smaller companies with no credit control function.

2. Invoice discounting tends to have a lower cost than factoring. This is because invoice discounting requires a lower service level than factoring – with invoice discounting, you do all the credit control and chasing of payment.

3. Invoice discounting is fully confidential meaning your customers are not aware that you are raising funds against their invoice and the funder has no contact whatsoever with your customers. Factoring on the other hand involves the lender taking over your credit control function and therefore liaising directly with your customers for payment of invoices.

So, if you answer yes to any of the following questions, then your business may be suitable for confidential invoice discounting:

  • Do you provide goods or services to other businesses i.e. B2B?
  • Do you issue your customers with credit terms of 30 days or more?
  • Is your business financially viable and has it been trading for a minimum of 2 years?
  • Does your business have a minimum turnover of £250,000?
  • Do you prefer to manage your own credit control function?
  • Can you can demonstrate a strong credit control and collections function within the business?

These are important points because the funder you approach will ask these questions and in particular will require you to be able to demonstrate that you have a strong credit control function within your business.

For this reason, invoice discounting is more likely to be suitable for medium to large businesses. Usually, small businesses, sole traders and start-ups do not have a strong enough credit control function to make invoice discounting an option which is why factoring is often a better option for them.

How does Invoice Discounting work?
Having successfully applied for a confidential invoice discounting facility, your lender will have agreed with you a maximum facility stated as a percentage against the value of your sales ledger. This is likely to be in the region of 80%-95% of your invoice value.

You then continue to supply your goods or services in the normal way and raise an invoice for the goods or services supplied, which you send to your customer.

At the same time, you need to submit a copy of the invoice to your finance provider or lender.
They will then release funds into your company against the value of the invoice that you have submitted up to the pre-agreed limit.

As I mentioned previously, because your facility is “confidential”, this means your lender or finance provider has no contact with your customer. As a result, your customer remains completely unaware that you have raised funds against their invoice prior to it being paid.

You then run your credit control function within your business in the normal way, collecting payment when it is due and chasing customers for non-payment of invoices when relevant.

The key point is how your customers make payment of funds if you are invoice discounting as opposed to not invoice discounting.

If you do not have invoice discounting in place, then your customers will simply transfer funds into your company bank account in the usual way.

However, if you are invoice discounting, the finance provider or lender opens a separate bank account in your company’s name into which your customers transfer funds in payment of their invoices. So as far as your customer is concerned, they are paying you directly.

However to be clear, the bank account that is set up is a trust account, with the lender being the trustee. This means that the bank account is in the name of your company, and your company is the beneficiary, however, because the account has been set up by the lender, as trustees of the account, the account is in fact under their control.

Settlement is then made by the lender to you. This means, that having already received let’s say 85% of the value of an invoice from the lender as a facility, having received payment of the invoice into the trust account, the lender now pays to you the balance of the invoice less their costs for providing the facility.

Having explained in this week’s blog the main differences between invoice discounting and factoring and how invoice discounting works, next week I’ll look at both the costs of invoice discounting as well as the pros and cons.

In the meantime, if you are currently experiencing cash flow problems within your business and want to talk to an expert, then email us at or give us a call on 020 8949 2122 and let’s see how we can help.