Invoice factoring for small businesses

What is invoice financing?

Invoice financing is the name given to a range of financing services - including invoice factoring and invoice discounting - based on outstanding invoices.

Invoice financing allows suppliers (exporters) to improve cash flow by receiving advances from a third-party finance provider against their unpaid invoices.

The invoice factoring company pays the supplier a percentage of the outstanding invoice amount to 'buy' the invoice. Once the invoice is settled in full by the importer, the factoring provider passes the remaining balance to the supplier, minus a small fee.

For example:

Exporter Ltd is owed £10 000 (GBP) by Importer Ltd after invoicing it for payment with 90-day terms. However, Exporter Ltd needs cash now, so it sells the invoice to an invoice financing company (Stenn).

Stenn pays 90% of the invoice value (£9 000 (GBP)) to Exporter Ltd within 48 hours of the relevant signed documents being approved.

Importer Ltd pays the £10 000 (GBP) invoice amount to Stenn after 90 days, with Stenn paying the remaining £1 000 (GBP) to Exporter Ltd, minus a pre-agreed fee.

Can small businesses access invoice financing services?

Invoice financing services are used by businesses of all sizes - often engaged in international trade requiring delayed payment terms.

Many invoice factoring companies will simply require businesses applying for finance to meet a minimum annual turnover threshold to qualify - but this can disqualify many new or small businesses.

However, with 82% of businesses failing because of poor management of cash flow, it is important for small businesses to be able to access funds. Compared with their larger competitors, SMEs typically have fewer financial assets to support applications for traditional loans.

Thankfully, small business factoring services are still available with certain lenders. Invoice factoring providers that specialise in lending to small and medium-sized businesses - such as Stenn - finance invoices starting from just $10 000 (USD).

The principles of small business invoice financing are the same as agreements with larger businesses. However, there are some important considerations for small businesses.

For smaller businesses, the fees associated with invoice financing services may represent a more significant investment than they do for businesses with a greater annual turnover. Similarly, some lenders will require a credit check on the importing business, so suppliers should be sure their trading partners are able to meet the requirements to qualify for this type of finance.

Small business invoice financing - pros and cons

Here, Stenn looks at the advantages and disadvantages of invoice financing for small and medium-sized businesses.

 Advantages of small business factoring 

Invoice financing can be a beneficial service for small businesses, allowing them to qualify for finance where they may be turned away by traditional lenders and giving them immediate access to capital.

The key benefits of these services include:

• Cash flow - instant access to liquid capital allows the business to pay its own expenses and fund growth projects.

• Avoid debt - invoice financing allows businesses to avoid the financial impact of delayed payments and, as a result, avoid missing their own payments. This prevents businesses from accruing debts, overdrafts and penalties.

• Instant cash - compared with alternative financing options with longer approval processes, invoice financing provides instant access to liquid capital.

• Improved relationships with clients - as the business can afford to offer delayed payment terms to customers without impacting its own finances.

• Unsecured finance - unlike some loan agreements, invoice financing agreements do not require suppliers to pledge any assets as collateral.

• Reduced risk - compared with the risks associated with traditional borrowing, invoice financing only sees businesses gain immediate access to funds they already

 Disadvantages of small business factoring

As with any financing service, invoice factoring presents potential risks and downsides that small businesses should be aware of.

These include:

• Fees - the small, pre-agreed service fees charged by the finance provider inevitably reduce the profit available to the borrowing business.
• Potential for rejection - some finance providers require a credit check on the customer prior to the agreement, which could see funds denied if the client is unable to meet the lender's criteria.
• Only available to those owed funds - invoice financing is based on accounts receivable and therefore is not a viable financial solution for businesses that simply need a cash loan.
• Not always confidential - non-recourse factoring agreements require the financer to collect invoice payments directly from the customer. This means the client knows the supplier is using a finance provider, something the supplier may wish to keep secret.

Invoice factoring for sole traders

Invoice financing services are available to sole traders in the same way as they are small, medium-sized and large businesses.

Factoring companies typically approve or reject applications based on the amount of finance requested and other factors such as the annual turnover of the supplier and importer. However, granted the business meets these requirements, they are unlikely to be turned away simply on the basis that they are a sole trader.

Invoice factoring represents a beneficial opportunity for sole traders, providing instant access to liquid capital - that may typically be unavailable for smaller businesses - to fuel growth and avoid bad debt or overdraft fees.

Sole traders may benefit from 'selective invoice financing' services - where invoice factoring services are provided for a single invoice at a time, with no long-term obligations to finance further accounts receivable with the lender.

For example, a sole trader that typically deals with orders of up to £5 000 (GBP) in value confirms an order worth £50 000 (GBP) with 90-day payment terms. This requires the business to order greater stock from its manufacturer and incur greater logistics costs than in its usual agreements. However, the business's current finances do not cover its short-term accounts payable.

The trader sells the £50 000 invoice to a factoring provider for an initial sum of £45 000 - accessing the funds immediately and agreeing to pay a 3% service fee. The business is then able to facilitate the trade and, after 90 days, the customer makes the full payment to the factoring provider. The provider then pays the remaining £5 000 owed to the business, minus the agreed 3% service charge.

Frequently Asked Questions (FAQs)

• Is invoice financing a good idea?

Invoice financing services offer many benefits to small businesses, including freeing up liquid capital to invest elsewhere and avoid bad debt, as well as improving relationships with customers by facilitating delayed payment terms.

However, as with any financial service, businesses should research their options and consider the potential limitations of the offering - such as whether they can afford the fees involved with accessing invoice factoring - before committing to an agreement.

• Is invoice financing easy to get?

Invoice financing services can be simple to qualify for, compared with alternative financing services such as traditional bank loans. Many invoice financing providers only require businesses to submit the relevant invoices and pass a credit history check to qualify.

With Stenn, businesses can access funds within 48 hours of a successful application and are only required to sign two documents.

In conclusion

Any small business financing service has benefits and limitations, so SMEs must understand the nuances of each service before applying.

Here, Stenn summarises the key points to keep in mind when it comes to small business invoice financing:

• Invoice financing is the name given to services in which businesses leverage the value of their unpaid invoices for immediate cash.
• Small business factoring services are available, however, they may still require a minimum invoice value - or annual turnover - to be met.
• The fees involved in invoice financing agreements may represent a more significant investment for small businesses compared with larger competitors engaged in high-value trade.
• Selective invoice financing may be beneficial to small businesses or sole traders engaging in trade agreements higher in value than their typical agreements.

Small business invoice financing with Stenn

Stenn provides invoice financing services for small and medium-sized businesses engaged in international trade and working with delayed payment terms.

Work with Stenn to turn unpaid invoices into liquid capital today or find out more about alternative financing options available to your small business in our Resources Hub.

About the Authors

This article is authored by the Stenn research team and is part of our educational series.

Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.

Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required.

‍No collateral is needed and funds are transferred within 48 hours of approval.

Check the financing limit available on your deal or go straight to Stenn's easy online application form.

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Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. It is for information only and doesn't constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.