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What is invoice finance?
Invoice finance is a common form of business finance in Australia, where a business sells its invoices to a lender or third-party company (known as a factor) who advances a large portion of the invoice amount to the business.
It allows a business to access funds quickly, without taking on a business loan that will accrue interest. It also doesn’t require collateral and the amount you can borrow will be relative to the value of your invoices (minus the factor’s fee).
The factor facilitating the finance is a third party that buys invoices from businesses for a portion of the invoice value, then collects full payment from the customer and pay the business the remainder of the invoice, keeping a pre-agreed percentage as their fee.
In Australia, invoice finance is often used by companies experiencing regular payment delays from customers, including labour hire, manufacturing, mining services, commercial property services and construction.
Why choose invoice finance?
- It's easy to set up
- It's offered by a variety of business finance lenders
- Once set up, it offers very fast access to cashflow (smoothing over cashflow is the most common reason businesses apply for finance according to business lending data)
- It's highly beneficial to small businesses or those operating with upfront costs
- It uses outsourced payment collection for a small fee
- Can be particularly useful if your business has reliable customers
One potential drawback of invoice finance is the fact that by selling your invoices to a third party, your business loses control over part of its sales process. This may impact the relationship with customers who are now dealing with your factor company.
For this reason, some business choose to keep their invoice payment collection in-house and use other sources of short-term business finance instead, including the likes of unsecured business loans and options for accessing a revolving business line of credit from a lender – for example, through a business overdraft.
Who is eligible for invoice finance?
You can qualify for invoice finance if you operate a business that provides a service or product to customers without immediate payment — i.e. your business sends an invoice to customers.
Here are some of the other main eligibility criteria:
- Own a business and have an ABN
- Business is GST-registered
- You are a citizen or permanent resident
- Your business has been operating for at least six months
- Business has invoices outstanding with customers
- Uses an accounting software program (i.e. Xero, MYOB)
How does invoice finance work? (7 steps)
Here's a simple example demonstrating how invoice finance works:
1
You send an invoice to a customer for $20,000
2
You send the invoice to the factor
3
The factor company agrees to charge you a fee of 3% on the invoice amount ($600)
4
The factor advances you a majority of the invoice amount in advance (85% or $17,000)
5
The factor awaits payment from your customer
6
The customer makes payment to the factor
7
The factor pays you the remaining invoice amount (12% or $2,400) minus their fee.
The amount you can receive from invoice finance will depend on the value of your invoices and the willingness of the factor to take them on. In general, most factors will advertise a maximum amount of $1,000,000 although some lenders offer a maximum amount of $100,000,000.
Compare invoice finance options
Invoice finance is often available either as recourse or non-recourse factoring, and through a whole ledger factoring or spot factoring agreement. You can see how these works below, starting with recourse versus non-recourse factoring compared.
Recourse factoring
With recourse factoring, you sell the debt to a factor who pursues the debt. But the risk remains with you. If your customer doesn’t pay their invoice, you will have to buy back the invoice, and chase it up yourself. This form of invoice finance can be easier to be approved for.
Non-recourse factoring
You sell the debt as well as the risk to the factor, meaning the factor is responsible for the debt. For this reason, you can expect to pay higher fees and not every factor will offer it. It’s generally only offered on invoices where your customer has a solid credit record.
Whole ledger factoring
With whole ledger factoring, you are required to sell all invoices relating to a particular customer. This is more restrictive but the fees are generally lower.
Spot factoring
Spot factoring allows you to pick and choose which invoices you want to sell. This gives you greater flexibility but there tend to be higher fees.
Invoice finance fees (factor fees) and other costs
The main cost of invoice finance is the ‘factor fee’ — a percentage of the invoice amount, and will generally be between 1.5% - 4.5%. The factor fee is the amount taken by the lender in return for their factoring services.
Factor fees will vary depending on the lender, the agreed invoice financing term, the volume of invoices you are factoring, and more.
There are also other considerations specific to your business and customers that will impact the invoice finance fee that applies, including:
- The creditworthiness of the customer
- The reliability of payment from customers
- The industry your business operates in
- The payment terms of your invoices — you’ll pay more on an invoice due in 90 days than one due in 30.
Applying for invoice finance
The process for setting up invoice finance is fairly simple. As your business won’t be taking on any debt, approval should be quicker than a standard loan application (with less emphasis on your credit score and history), and will often require less-exhaustive documentation. You’ll need to complete a simple application form and supply supporting documents.
Documents required when applying for invoice finance:
- Proof of identity
- An ABN and GST registration
- A list of your customers
- Copies of the invoices you want to factor
- A report for your accounts receivables, showing how frequently customers pay their invoices
- Business bank statements
