Invoice financing, particularly invoice discounting, is an increasingly popular way for businesses in the UK to manage their cash flow. However, one of the first questions business owners ask is: how much does it cost? Below, we’ll dive into the key components of invoice discounting, how it works, and what costs you should anticipate.
What is invoice discounting?
Invoice discounting is a variant of invoice finance that allows businesses to unlock cash tied up in outstanding invoices. Unlike invoice factoring, where a finance provider takes over credit control, invoice discounting enables you to retain full control over customer relationships and payment collections.
This means you’ll still be responsible for chasing unpaid invoices, but the benefit is confidentiality and less reliance on third parties. The cash unlocked can be used for anything from meeting operational costs to expanding your business.
To qualify for invoice discounting, most providers require that you:
- Issue B2B or commercial invoices with payment terms of 30 days or more.
- Have a net turnover of at least £250,000 annually.
- Have a robust admin and credit control function
Understanding the costs of invoice discounting
The overall cost of invoice discounting varies depending on your agreement and provider. Here’s a breakdown of the key fees to consider:
1. Service fees
Service fees cover the cost of managing your facility. These are typically paid monthly and calculated as a percentage of your annual turnover.
For medium-sized businesses, service fees often range from 0.2% to 0.5% of turnover.
The exact cost depends on factors such as:
- Your annual turnover.
- The number of customers and invoices you raise.
- The complexity of your business and type of industry you are in.
Service fees for invoice discounting tend to be lower than those for invoice factoring since you maintain responsibility for chasing outstanding invoices.
2. Discounting
Discounting works exactly the same way as interest on an overdraft. It is called discount as opposed to interest because technically the lender is purchasing the invoice as opposed to lending against it. You pay a discount rate for the days in which you borrow money. it is calculated on a daily basis and charged monthly in arrears. Discount ranges from 1.5% to 3.5% above a bank rate – BoE base or SONIA. Discount will vary depending on:
- The provider you choose (each lender will have a different cost of capital).
- The perceived risk the lender places on lending you the money.
3. Additional costs
Depending on the terms of your agreement, you might encounter additional fees, such as:
- Early termination charges: Fees incurred for ending your contract early.
- Trust account fees: A fee for operating the facility.
- CHAPS fees: Payable for transferring funds to you same day
- Credit protection fees: Charges for insuring your invoices against non-payment.
There can be plenty of other types of charges and these vary wildly from lender to lender. For this reason, it is incredibly important to read through the terms of your agreement in detail.
How to manage costs effectively
To ensure your invoice discounting solution is cost-effective:
- Compare providers: Fees can vary significantly between providers, so take the time to shop around.
- Understand terms: Be clear on all potential charges, including additional or hidden fees.
- Choose the right fit: Select a provider whose terms align with your business needs and operations.
The bottom line
Invoice discounting is a flexible and confidential way to improve your business’s cash flow without sacrificing equity or high-value assets. While costs such as service and discounting fees apply, these are manageable when weighed against the benefits of access to immediate cash.
There isn’t a league table of invoice finance providers. A specific lender might be the best for one company and the worst for another. With such a key aspect of your business, understanding each lender and who is best for YOU is vital. Often a specialist broker will know this, saving you a lot of time and luck in finding the right fit.