How does invoice financing work?

Invoice financing works by using your unpaid invoices as security, letting a lender advance you up to 90% of their value in as little as 48 hours instead of waiting the usual 30 to 90 days for your customer to pay. Once your customer settles the invoice in full, the lender releases the remaining balance to you, minus their fees. Borrowing against money you are already owed rather than money you might earn in future, is what makes invoice financing different from a standard business loan.

The invoice financing process step by step

Invoice financing runs in two stages: setting up your facility once, then a repeating cycle every time you raise an invoice. Here’s how it works step by step:

1. You set up a facility with a lender. The lender reviews your business, your typical customers and your sales ledger, then agrees a facility limit and fee structure. This usually takes a few days to a couple of weeks, depending on the lender and how ready your paperwork is.

2. You deliver the work and raise the invoice as normal. Your business supplies the goods or service and sends the invoice to your customer on its usual payment terms.

3. You submit the invoice to your lender. Many lenders connect directly to your accounting software, so this step can happen automatically as soon as an invoice is raised, rather than through separate paperwork each time.

4. Your lender advances a percentage of the invoice value. This is typically up to 90%, usually landing in your account in as little as 48 hours of approval.

5. Your customer pays the invoice on its normal terms. Who they pay directly depends on whether your facility is disclosed or confidential, which the sections below cover in more detail.

6. Your lender releases the remaining balance, minus their fees. Once the invoice is settled in full, you receive what is left after the service charge and discount rate have been deducted.

Once your facility is live, steps two to six repeat for every invoice you raise, so funding keeps pace with your sales rather than needing a fresh application each time.

How much of an invoice's value do you actually get, and when?

Invoice financing pays out in two parts rather than one lump sum. The first payment, the advance, lands in as little as 48 hours of your lender approving the invoice, and is typically up to 90% of its value. The second payment, the remaining balance, only arrives once your customer has actually paid the invoice in full, and it is what is left after your lender's service charge and discount rate have been taken off. In practice this means you are never funding 100% of an invoice upfront, and the exact size of that second payment depends on how long your customer takes to pay, since the discount rate is charged for every day the money is outstanding.

How is invoice financing priced?

Invoice financing is priced through three separate charges rather than a single interest rate, and each one reflects a different part of what the lender is doing for you.

A stronger business credit score and customers with a reliable payment history usually bring your service charge and discount rate down, since the lender is taking on less risk.

A worked example of how invoice financing works

Say your business raises a £20,000 invoice with 60 day payment terms. Your lender approves it and advances 85%, or £17,000, which lands in your account in as little as 48 hours. Your customer pays the full £20,000 on day 55. Your lender then releases the remaining £3,000, minus a service charge of 1.5% of the invoice value, £300, and a discount rate charged daily on the amount advanced over those 55 days. Once both fees are deducted, you receive the balance left over, having had access to most of that £20,000 nearly two months before your customer actually paid it.

Who is involved in an invoice financing facility?

Every invoice financing arrangement involves three parties:

• Your business. You raise the invoice, submit it to your lender, and receive the advance and balance payments.

• Your lender, sometimes called your factor. They advance funds against your invoice, charge their fees, and either collect payment from your customer directly or wait for you to collect it, depending on the type of facility.

• Your customer, sometimes called the debtor. They owe the money on the original invoice and pay it on the agreed terms, either to you or directly to your lender.

Will your customer know you’re using invoice financing?

Whether your customer knows depends entirely on which type of facility you choose, since this changes who they actually pay. With a disclosed facility, most commonly invoice factoring, your lender collects payment directly from your customer, so they are aware a lender is involved. With a confidential facility, you keep collecting payment yourself and your customer continues dealing with you exactly as before, unaware a lender is involved at all.

Which type of invoice financing fits how you work?

Which specific type of invoice financing you choose changes two things: who collects payment from your customer, and whether you finance your whole sales ledger or just some of it. Here’s an overview of the options and how they work:

• Invoice factoring works on a disclosed basis, with your lender collecting payment and taking on credit control for your whole ledger.

• Spot factoring is very similar to invoice factoring, but applies it to a single invoice as a one off, with no ongoing contract.

• Invoice discounting works confidentially, with you keeping your own credit control across your whole ledger.

• Selective invoice finance can work either as a factoring or discounting facility. It lets you apply the same advance and balance mechanic to individual invoices or customers, rather than your whole ledger.

As well as different types of invoice finance, there are multiple different lenders offering different features. Our roundup of top invoice finance providers compares named lenders from our panel side by side.

Want to see invoice financing working for your business?

Now you know how invoice financing works step by step, it may be an option worth exploring. You can apply for invoice finance through Capitalise and we'll match your application against our panel ofUK lenders, with a dedicated funding specialist guiding you from application through to your first advance landing in your account.