What is invoice finance and how does it work?

If you sell to other businesses on 30, 60 or 90-day terms, you pay your staff and suppliers before your customers pay you. Invoice finance closes that gap. A provider advances cash against invoices you have already issued, and the invoices themselves are the main security.

This article explains the mechanics. If you want to know how invoice discounting, factoring and debtor finance differ, read our comparison guide invoice finance vs debtor finance vs factoring.

How invoice finance works

Most facilities follow the same cycle.

1. You do the work and issue the invoice. The customer must be a business or government body buying on credit terms.
2. You submit the invoice to the provider. Depending on the facility, you may upload single invoices or give the provider access to your whole receivables ledger through your accounting software.
3. The provider checks it. It confirms the invoice is genuine, the work is complete and the customer is acceptable. It may contact the customer to verify the invoice.
4. You receive an advance. The provider pays you an agreed share of the invoice value. The rest is held back as a buffer.
5. Your customer pays. Depending on the facility, the customer pays the provider directly or pays into an account the provider controls.
6. The provider settles up. It recovers the advance and its fees, then pays the remaining balance to you.

With a revolving facility, this cycle repeats. As you raise new invoices, the amount you can draw goes up. As customers pay, it comes down.

A worked example

This is an illustration only, with round numbers. It does not reflect any provider’s pricing or advance rate.

• You issue a $50,000 invoice to a business customer on 45-day terms.
• Two days later, the provider advances $40,000 to your account. The other $10,000 is held back.
• On day 45, your customer pays the full $50,000.
• The provider keeps the $40,000 advance plus its fees and interest for the period.
• It then pays you the remaining $10,000, less those fees and interest.

The result is that you received most of the invoice value about six weeks earlier. The cost is the fees and interest, which you should weigh against what the early cash lets you do, or avoid.

If the customer paid late, on day 75 instead of day 45, time-based charges would usually keep running. Late payers make invoice finance more expensive.

Disclosed and confidential facilities

Disclosed. Your customers are told that you use a finance provider and are asked to pay the provider. Factoring is usually disclosed, and the provider often manages collections for you. This can save you time, but it means a third party is contacting your customers.

Confidential. You keep collecting from customers yourself, and they usually do not know a provider is involved. Invoice discounting is usually confidential. Providers generally expect stronger bookkeeping and credit control before they offer it.

Recourse and non-recourse

Recourse. If a customer does not pay, you carry the loss. After a set period, the provider will ask you to repay the advance or replace the invoice with another one. Most facilities are recourse.

Non-recourse. The provider takes on some or all of the risk that an approved customer cannot pay because it is insolvent. This usually costs more, and there are limits. Cover often applies only to approved customers and set amounts, and it may not cover disputed invoices. Read what “non-recourse” covers in your contract rather than relying on the label.

What the cost is made of

business.gov.au notes that selling invoices to a factor company can be expensive compared with other finance, so understand every part of the cost. Charges vary between providers, but they are usually built from some mix of:

• a service or discount fee, charged per invoice or as a share of the invoices you finance
• interest or a time-based charge on the funds you have drawn, for as long as they are outstanding
• set-up, due diligence or legal fees to establish the facility
• ongoing account or minimum-usage fees, which you may pay even in months you finance little
• collection or administration fees, particularly with factoring
• extra charges for non-recourse cover, for invoices paid late, or for ending the facility early

Ask for an estimate of the total cost for a typical month, based on your actual invoice sizes and how long your customers take to pay.

Who invoice finance suits

Invoice finance tends to suit businesses that:

• sell to creditworthy business or government customers on credit terms
• are growing, so receivables rise faster than cash
• have seasonal peaks or large contracts that tie up cash
• do not have, or do not want to offer, property as security

It tends not to suit businesses that sell mainly to consumers, have many small or disputed invoices, rely on progress claims that customers often contest, or depend on one customer who pays slowly. Providers look closely at who owes you money, as well as at your business.

Alternatives to consider

Finance is not always the answer to slow-paying customers. Options include:

• Tighten your payment terms. business.gov.au suggests clear terms on invoices and contracts, credit checks before you give credit, credit limits, deposits for special orders, and discounts for early payment or fees for late payment.
• Invoice sooner and chase earlier. Automating invoices through accounting software and following up politely as soon as a payment is late can shorten the gap. See what to do when customers pay late.
• Negotiate with your suppliers. Longer supplier terms can balance slower customer terms.
• A line of credit or overdraft. These are not tied to specific invoices. Compare them in line of credit vs term loan.
• Talk to your accountant. If cash shortfalls are frequent, the cause may be pricing, margins or costs rather than timing. Our guide to working capital explains how to measure the gap.

Step by step

1. List your receivables. Note each customer, invoice amount and how long they usually take to pay.
2. Work out the gap. Estimate how much cash you need, and for how long, before customers pay.
3. Try the free fixes first. Review your payment terms and collections process.
4. Decide what matters to you. Consider whether customers may be told, who should collect and whether you need bad-debt cover.
5. Compare total costs. Ask each provider for a worked cost estimate using your real invoices, and check any minimum terms, minimum fees and exit costs.
6. Read the security documents. Check whether the provider will also take a general security interest or a director guarantee.
7. Get advice. Ask your accountant how the facility will affect your cash flow, bookkeeping and other lending.

Important things to know

• It is still debt. Under a recourse facility, you must repay advances on invoices your customers do not pay.
• Security usually goes beyond the invoices. Many providers also take a general security interest over business assets and guarantees from directors.
• Contracts can lock you in. Some facilities have minimum terms, notice periods or fees for leaving. Check them before you sign.
• Disputes slow everything down. A disputed or credited invoice may not be funded, or may need to be repaid.
• Check your customer contracts. Some contracts restrict assigning or selling the debts owed under them. Your lawyer or the provider can check this.

Compare invoice finance, debtor finance and factoring options when you are ready.