Invoice Finance: Factoring and Invoice Discounting Explained

Invoice finance allows businesses to access money tied up in unpaid customer invoices rather than waiting 30, 60 or 90 days to be paid.

The finance provider advances a proportion of the value of eligible invoices, giving the business earlier access to working capital.

The two main types of invoice financing for business funding are invoice factoring and invoice discounting.

Both can improve cash flow, but they differ in who manages customer payments, how visible the arrangement is to customers and the type of business they are typically suited to.

This guide explains how invoice finance works in the UK, the difference between factoring and invoice discounting, typical costs and eligibility requirements, and when it may be a suitable form of business funding.

What Is Invoice Finance?

Invoice finance is a form of business funding that uses unpaid customer invoices to support borrowing.

Instead of waiting for customers to settle their invoices, a business can receive a proportion of their value from an invoice finance provider earlier.

For example, suppose your business issues a customer invoice for £50,000 with 60-day payment terms.

Rather than waiting two months for the full £50,000, an invoice finance provider might advance a significant proportion of the invoice shortly after it is raised.

When the customer eventually pays, the remaining balance is released after the provider deducts its agreed charges.

The British Business Bank describes invoice finance as a way for businesses to bridge the working-capital gap between supplying goods or services and receiving payment from customers.

How Does Invoice Finance Work?

Although individual facilities vary, the process generally works like this:

1. You supply goods or services

Your business completes work for another company and issues an invoice.

For example:

Invoice value: £100,000
Payment terms: 60 days

2. The invoice is included in the finance facility

The invoice is made available to the finance provider according to the terms of the agreement.

3. The provider advances a percentage

The provider releases an agreed percentage of the invoice value.

The British Business Bank notes that invoice finance providers may advance up to around 80% or 90% of eligible invoice values, although the actual percentage depends on the provider's risk assessment.

Using an illustrative 85% advance:

Invoice value: £100,000
Advance rate: 85%
Initial funding: £85,000

4. Your customer pays the invoice

The customer eventually settles the £100,000 invoice.

Who collects that payment depends on whether you are using factoring or invoice discounting.

5. The remaining balance is released

The remaining value is paid to the business after the provider deducts the applicable fees and finance charges.

This effectively converts outstanding invoices into a source of working capital.

What Are the Main Types of Invoice Finance?

The two main types are:

• Invoice factoring
• Invoice discounting

Other arrangements such as selective invoice finance and spot factoring also exist.

However, factoring and discounting account for the main distinction most businesses need to understand.

What Is Invoice Factoring?

Invoice factoring combines finance with sales-ledger and credit-control support.

The factoring company typically:

• Advances a proportion of eligible invoice values
• Manages the sales ledger
• Contacts customers for payment
• Collects the invoice directly

Because the provider is involved in collections, customers will generally know that the business is using a factoring facility.

Factoring may therefore provide both:

Funding – earlier access to invoice value.

Administration – outsourced credit control and payment collection.

The British Business Bank notes that factoring is often more accessible to smaller businesses and that providers may also carry out customer credit checks and support sales-ledger management.

What Is Invoice Discounting?

Invoice discounting provides finance against unpaid invoices but normally leaves the business responsible for collecting payment from customers.

The company continues to manage:

• Customer relationships
• Credit control
• Sales ledger
• Payment collection

The provider primarily supplies the finance facility.

Invoice discounting is therefore usually more suitable for businesses with established financial controls and an effective internal credit-control function.

The British Business Bank says invoice discounting is more commonly used by established businesses with larger turnovers, although availability for smaller companies is increasing.

What Is Confidential Invoice Discounting?

Many invoice discounting facilities are confidential or undisclosed.

This means customers may not be aware that the business is using invoice finance.

The company continues to:

• Raise invoices in its normal way
• Communicate directly with customers
• Manage collections
• Maintain the customer relationship

This differs from factoring, where the provider generally becomes visibly involved in collecting the debt.

Confidential invoice discounting can appeal to established businesses that want working-capital funding without changing the way their customers interact with them.

Invoice Factoring vs Invoice Discounting

The main difference is who controls the sales ledger and customer collections.

Both release cash against unpaid invoices.

The right option depends on how much control you want to retain and whether your company already has the systems needed to manage receivables effectively.

Example: Invoice Factoring vs Invoice Discounting

Suppose a business has £500,000 of eligible unpaid invoices.

If a provider makes 85% available:

Invoice ledger: £500,000
Advance rate: 85%
Potential availability: £425,000

With factoring, the provider may then:

• Advance the funding
• Manage collections
• Receive payments directly from customers

With invoice discounting, the business would usually:

• Receive access to the funding
• Continue pursuing customer payments itself
• Operate the sales ledger internally

The underlying funding principle is similar.

The service surrounding it is different.

What Is Selective Invoice Finance?

Selective invoice finance allows a business to finance particular customer accounts or groups of invoices rather than entering a facility covering the entire sales ledger.

This can provide greater flexibility where finance is only needed:

• Occasionally
• For one major customer
• During a period of rapid growth
• For particular contracts

What Is Spot Factoring?

Spot factoring allows individual invoices to be financed.

For example, a business might have one unusually large £150,000 invoice but no ongoing requirement to finance the rest of its debtor book.

Instead of taking a full ongoing factoring facility, it may be possible to finance that individual invoice.

Selective and spot facilities can be useful where working-capital requirements are occasional rather than permanent. The British Business Bank recognises both as alternatives to traditional ongoing factoring and discounting arrangements.

Who Is Invoice Finance Suitable For?

Invoice finance is mainly relevant to B2B businesses that sell on credit terms.

Potential users include:

• Manufacturers
• Wholesalers
• Recruitment companies
• Professional services firms
• Transport businesses
• Engineering companies
• Construction-related businesses
• Distributors

It can be especially useful where a company is profitable and growing but has significant cash tied up in its debtor book.

Why Do Businesses Use Invoice Finance?

The main reason is working capital.

Imagine a company that:

• Pays employees every month
• Pays suppliers within 30 days
• Gives customers 60-day payment terms

Even if the company is profitable, there is a timing mismatch.

Cash leaves the business before customer payments arrive.

Invoice finance can help bridge that gap.

Invoice Finance and Rapid Growth

Growth can actually increase working-capital pressure.

Suppose a business doubles monthly sales from £200,000 to £400,000.

That sounds positive.

But if customers pay after 60 days, the amount tied up in unpaid invoices can also rise substantially.

The company may need more money for:

• Employees
• Materials
• Stock
• Suppliers

before receiving cash from its increased sales.

Because invoice finance availability can increase as the eligible debtor book grows, it can potentially scale alongside the business. The British Business Bank describes this as a dynamic working-capital facility where increased invoice activity can unlock additional funding.

Advantages of Invoice Finance

Faster access to cash

The biggest advantage is reducing the wait between issuing an invoice and accessing some of its value.

Once an established facility is operating, funding against new invoices can often be made available quickly.

Improves working capital

The cash released can potentially be used for:

• Payroll
• Stock
• Suppliers
• Rent
• Growth
• Investment
  
  

Funding can grow with turnover

As more eligible invoices are raised, the amount of available funding can increase.

Uses an existing business asset

The debtor book is already an asset on the company's balance sheet.

Invoice finance allows the business to make use of that asset as a source of funding.

Factoring can reduce administrative workload

With factoring, the provider takes responsibility for some or all of the sales-ledger and collection activity.

This can save internal time and resources.

Can support businesses where other finance is limited

Because the provider considers the quality of the debtor book and customers as part of the assessment, invoice finance can work differently from a conventional unsecured business loan.

Disadvantages of Invoice Finance

There is a cost

Businesses pay for the funding and, where relevant, the additional services.

Factoring affects the customer relationship

Because the factor manages payment collection, customers will usually know a third-party provider is involved.

Some businesses may prefer to retain direct control.

Not every invoice will qualify

Providers may exclude invoices or customers that do not meet their criteria.

Funding can fall if turnover falls

Because availability is based on unpaid invoices, a reduction in sales can reduce the amount of funding available.

Invoice finance should therefore not be treated as a fixed pool of capital.

It does not fix an unprofitable business

Invoice financing changes the timing of cash receipts.

It does not turn loss-making sales into profitable ones.

The British Business Bank specifically cautions that invoice finance advances cash flow and is not a substitute for an underlying sustainable business model.

How Much Does Invoice Finance Cost?

Pricing depends on the provider and structure.

Common charges may include:

Service fee

A fee for operating the facility.

For factoring, this may also cover:

• Credit control
• Sales-ledger administration
• Customer collections
  
  

Discount charge

This works in a similar way to interest.

It is generally calculated on the amount of funding actually being used.

Additional fees

Depending on the agreement, there may also be charges relating to:

• Setup
• Due diligence
• Minimum usage
• Bad-debt protection
• Early termination
• Other services

Because factoring includes additional administrative support, its service charge may be higher than a comparable invoice discounting arrangement.

What Is Bad-Debt Protection?

Some providers offer protection against customers failing to pay because of insolvency or other covered circumstances.

This may be offered alongside factoring or invoice discounting.

It can reduce exposure to certain customer defaults but normally comes at an additional cost.

Businesses should check:

• Which customers are covered
• The level of protection
• Any limits
• Exclusions
• Conditions for making a claim

Bad-debt protection should not be confused with the normal funding facility itself.

How Much Can You Borrow With Invoice Finance?

The amount available is directly connected to the value and quality of eligible outstanding invoices.

For example:

Eligible debtor book: £600,000
Advance rate: 85%

Potential availability could be:

£510,000

subject to provider criteria.

However, a provider may reduce availability where there are concerns such as:

• Customer concentration
• Old invoices
• Disputed invoices
• Poor payment history
• Overseas debtors
• Credit risk

The British Business Bank notes that advance rates often reach around 80% or 90%, but the provider determines the actual amount based on its assessment of the business and debtor book.

What Is Customer Concentration?

Customer concentration occurs when a large proportion of the company's invoices relate to one or a small number of customers.

For example:

Total debtor book: £500,000
Amount owed by one customer: £300,000

That one customer represents 60% of the outstanding invoices.

A provider may view this as additional risk because a problem with that customer could affect a significant proportion of the facility.

What Invoices Are Usually Eligible?

Exact requirements vary, but providers generally prefer invoices that:

• Relate to genuine completed B2B sales
• Are not disputed
• Are within normal payment terms
• Are owed by creditworthy customers
• Have clear supporting records

Old, disputed or unusual invoices may not qualify.

Who Is Eligible for Invoice Finance?

Eligibility varies by provider, but businesses commonly need to:

• Trade primarily with other businesses
• Offer customers credit terms
• Have a trading history
• Maintain accurate financial records
• Have an appropriate debtor book
• Invoice customers for completed goods or services

The provider may consider:

• Annual turnover
• Quality of customers
• Typical payment terms
• Credit-control processes
• Invoice disputes
• Bad debts

The British Business Bank notes that providers generally look at both the established trading history of the business and the quality of its outstanding invoices.

What Documents Might You Need?

An invoice finance provider may ask for:

• Annual accounts
• Management accounts
• Aged debtor report
• Aged creditor report
• Customer list
• Sales ledger
• Business bank statements
• Details of disputed invoices
• Credit-control information

The debtor book is particularly important because it forms the basis of the facility.

Invoice Finance vs a Business Loan

Invoice finance and conventional business loans can both provide working capital, but they work very differently.

A conventional loan may suit a defined project.

Invoice finance may suit an ongoing working-capital requirement linked directly to sales.

Read Business Loans and Debt Finance: How They Work for more information.

Invoice Finance vs an Overdraft

Both can help manage short-term cash flow.

An overdraft gives the business an agreed borrowing limit linked to its bank account.

Invoice finance is linked directly to receivables.

For businesses with substantial B2B invoicing, invoice finance may provide greater funding capacity because availability can increase as the debtor book grows.

The appropriate option depends on:

• Funding requirement
• Turnover
• Invoice profile
• Bank facilities
• Costs
• Flexibility

Invoice Finance vs Working Capital Loans

A working capital loan typically provides a fixed amount of finance.

Invoice financing works dynamically against outstanding receivables.

This means invoice finance may be particularly relevant where working-capital pressure rises as sales increase.

Read Working Capital Finance: Funding Day-to-Day Business Needs for a wider comparison.

Invoice Finance for Small Businesses

Invoice finance can be suitable for smaller B2B companies where customer payment terms create significant cash-flow pressure.

Factoring can be particularly relevant where the company does not have a large internal credit-control department because the provider can help manage collections.

Invoice discounting generally requires stronger internal systems because the business retains control of the sales ledger.

The British Business Bank notes that factoring has historically been easier for smaller businesses to access, while discounting is more commonly associated with larger established businesses.

Read Small Business Funding: Finance Options for UK Businesses for a wider look at SME funding.

Can Startups Use Invoice Finance?

Invoice finance generally works best for businesses that:

• Have started trading
• Already issue invoices
• Have a debtor book
• Sell primarily to other businesses

A pre-revenue startup therefore has nothing to finance through an invoice facility.

Some younger companies with genuine customer invoices may still have options, but provider criteria vary.

For businesses that have not yet built meaningful invoice activity, other startup funding routes are likely to be more relevant.

Read Startup Funding in the UK: Options for New Businesses for more information.

Can Invoice Finance Be Used to Fund Growth?

Yes.

One of its strongest use cases is supporting working capital during growth.

Suppose a business wins a major contract.

The company may need to:

• Hire staff
• Buy materials
• Increase stock
• Increase production

before the new customer pays its invoices.

Invoice finance can potentially release cash from those sales earlier, helping finance the increased operating costs.

Can Invoice Finance Be Used When Buying a Business?

Potentially, although it is not usually the only form of acquisition funding.

If an acquired company has a substantial eligible debtor book, invoice finance may form part of the wider transaction or post-acquisition funding structure.

For example, acquisition funding could involve:

• Buyer capital
• Acquisition debt
• Seller finance
• Invoice finance for working capital

The invoice facility might help ensure the business has sufficient working capital after completion rather than financing the full purchase price itself.

For the broader options, read our guide to financing a business purchase.

How to Choose Between Factoring and Invoice Discounting

The decision largely comes down to how much control your business wants and how strong its internal financial systems are.

Factoring may suit you if:

• You want credit-control support
• Your finance team is relatively small
• You are comfortable with customers knowing about the facility
• Outsourcing collections would save time
  
  

Invoice discounting may suit you if:

• You already have strong credit-control systems
• You want to retain customer contact
• Confidentiality is important
• Your company has a more established financial function

Questions to Ask an Invoice Finance Provider

Before entering an agreement, ask:

• What percentage of invoices will be advanced?
• Which invoices qualify?
• Which customers qualify?
• What is the service fee?
• How is the discount charge calculated?
• Are there minimum charges?
• Is bad-debt protection included?
• Is the facility confidential?
• Who handles collections?
• What happens with disputed invoices?
• How are concentration limits applied?
• What is the minimum contract period?
• What happens if I want to exit the facility?

These details can significantly affect the overall value and flexibility of the arrangement.

Is Invoice Finance Right for Your Business?

Invoice finance can be a useful working-capital solution for businesses that are profitable but regularly wait for customers to pay.

It can help release cash earlier, support growth and reduce pressure created by long payment terms.

The most appropriate form depends largely on how much control the business wants over customer collections.

Factoring combines finance with sales-ledger and credit-control support.

Invoice discounting gives the business access to funding while it generally retains responsibility for collections.

Before choosing either, assess:

• The quality of your debtor book
• Customer payment terms
• Funding requirement
• Costs
• Internal credit-control capability
• Confidentiality
• Contract length
• Alternative funding options

For a wider comparison of invoice finance alongside loans, asset finance, equity and other funding options, read Types of Business Funding: Which Option Is Right for You?

Protect Working Capital After Your Next Acquisition with Valius

Buying an established business is not only about funding the purchase price. You also need to consider how much working capital the company will require after completion.

If the business sells to other companies on credit terms and has significant cash tied up in unpaid invoices, invoice finance may potentially form part of the post-acquisition funding strategy.

At Valius, we help buyers discover established businesses for sale and navigate the wider acquisition journey, including valuation, due diligence, funding and deal structure.

Understanding a target company’s debtor book, customer payment terms and working-capital requirements before completion can help you assess how much cash the business will need once ownership transfers.

In the right circumstances, facilities such as invoice finance can help release cash from existing sales and give the acquired business more room to operate and grow.

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