How Can UK SMEs Leverage Invoice Factoring? A Comparison with Other Borrowing

Invoice factoring lets UK SMEs unlock cash tied up in unpaid invoices. It gives them faster access to working capital, so they don’t have to wait out long payment terms.

It allows a business to sell its invoices to a finance provider in exchange for most of the invoice value upfront. This boosts cash flow and can support growth.

If you work in an industry where payment delays are common but bills and wages can’t wait, this option can be a lifesaver.

Unlike traditional loans, invoice factoring relies on the value of outstanding invoices, not just your company’s credit history. That’s a relief for businesses with strong sales but not many assets or a short trading record.

Knowing how it works—and how it stacks up against other ways to borrow—helps business owners pick a solution that’s both flexible and cost-effective.

By looking at different types of factoring and comparing them to alternatives like overdrafts or asset finance, SMEs can figure out what fits best. It might mean less financial stress and more room to grow, all without piling on extra debt.

Key Takeaways

• Invoice factoring releases cash from unpaid invoices quickly
• It can be more accessible than some traditional borrowing options
• Choosing the right facility depends on cost, flexibility, and business needs

How Invoice Factoring Works for UK SMEs

With invoice factoring, a business sells its unpaid invoices to a factoring provider and gets an immediate cash advance. For UK SMEs, this can ease cash flow headaches and help cover costs—even when customers drag their feet.

The Invoice Factoring Process Step by Step

First, an SME issues an invoice to a customer, usually with payment terms of 30–90 days. Instead of waiting, the business hands the invoice over to a factoring company.

The factoring provider typically advances 80–90% of the invoice value within 24–48 hours. They then chase up payment from the customer.

When the customer pays, the factoring provider passes on the rest of the money to the SME, minus any agreed fees. These fees usually include a service charge and a discount rate based on the invoice size and how long it’s outstanding.

You can set this up for every invoice or just a few—it depends on the facility you choose.

Roles of the Factoring Provider and Company

In a disclosed factoring deal, the factoring provider handles credit control. They contact customers, send reminders, and keep track of payments.

The SME’s job is to deliver what they promised, raise accurate invoices, and share debtor details with the factor. The provider then takes over chasing payments, which can free up a lot of admin time.

Sometimes, like with invoice discounting, the SME keeps control over collections and customers don’t know about the arrangement. In that case, the provider just advances funds and keeps an eye on the account.

Who does what really depends on the type of facility and how much control the business wants to keep.

Eligibility Criteria for SMEs

Most UK SMEs can use invoice factoring if they trade on credit terms and invoice for finished work or delivered goods.

Factoring providers usually want to see a minimum monthly turnover, a steady debtor book, and a solid invoicing system. They’ll also look at how reliable the SME’s customers are, since that’s where repayment comes from.

If a business has lots of disputed invoices or a history of late payments, it might face higher fees or stricter terms. Some providers steer clear of industries with really long payment cycles or high default rates.

There are flexible options too, like selective invoice finance, which can be handy for smaller SMEs with seasonal cash flow ups and downs.

Types of Invoice Factoring and Related Solutions

There are several factoring arrangements out there, each with its own level of risk, flexibility, and involvement in customer payments. The best fit depends on customer reliability, cash flow needs, and how much control you want over credit management.

Recourse and Non-Recourse Factoring

With recourse factoring, the business stays on the hook if a customer doesn’t pay. If the invoice can’t be collected, the factoring company asks for the advance back. This option usually costs less since you’re still carrying some risk.

Non-recourse factoring shifts the risk of bad debt onto the factoring provider. If the customer goes bust or doesn’t pay for approved reasons, the factoring company takes the hit. This is often called bad debt protection.

Recourse works best for firms with reliable customers and steady payments. Non-recourse can make sense if you’re dealing with new clients or industries where defaults happen more often. The price difference can be big, so it’s really about weighing risk versus cost.

Selective and Spot Factoring

Selective factoring lets you pick which invoices to factor. You can use it only when there’s a cash crunch, without locking yourself into a long-term contract.

Spot factoring is pretty similar but usually means factoring just one invoice as a one-off. Handy if you need to buy stock for a big order or cover an unexpected bill.

These choices appeal to SMEs with seasonal sales or unpredictable payments. Fees per invoice might be higher, but the flexibility can make it worthwhile if you only need it occasionally.

Confidential Factoring and CHOCCS

With confidential factoring, customers don’t know a factoring deal exists. The business keeps handling its own credit control and collections, while the factoring provider quietly advances funds in the background.

CHOCCS (Customer Handles Own Credit Control Service) is similar. The business still chases payments, even though the factoring company supplies the cash. This can help keep customer relationships strong and avoid any awkward questions.

Both setups need good internal credit control. They’re popular with companies that want the benefits of factoring without changing how customers interact with them.

Reverse Factoring Explained

Reverse factoring (or supply chain finance) flips things around. The buyer arranges with a finance provider to pay suppliers early, often at a better rate thanks to the buyer’s stronger credit.

Suppliers get paid faster, which helps with their cash flow. The buyer then settles up with the finance provider later, on agreed terms.

This setup can strengthen supplier relationships and sometimes lead to better deals. You’ll see it most in industries where big buyers work with lots of smaller suppliers who might otherwise be left waiting for payment.

Invoice Factoring vs Other Types of Business Borrowing

Business finance comes in all shapes and sizes. How you get funds, how you pay them back, and who chases your customers can all change depending on what you pick.

Invoice Factoring vs Invoice Discounting

With invoice factoring, you sell unpaid invoices to a finance provider, and they collect from your customers. You get an advance—usually 80–90% of the invoice value—minus fees.

Invoice discounting is different. You use unpaid invoices as security for a loan or credit line, but you still collect payments yourself.

Key differences:

FeatureInvoice FactoringInvoice DiscountingControl of collectionsFinance providerBusinessCustomer awarenessCustomers deal with providerCustomers unawareTypical advance rate80–90%Up to 95%

Discounting often suits businesses with strong internal credit control, while factoring is handy for those who’d rather not chase payments themselves.

Invoice Factoring vs Business Loans

A business loan gives you a lump sum to pay back over time, with interest. The amount you get doesn’t depend on invoices, and you’ll probably need a solid credit record or collateral.

Invoice factoring, on the other hand, frees up cash that’s tied up in invoices. Approval leans more on your customers’ reliability than your own.

Loans offer predictable repayments and might be cheaper for long-term needs. Factoring is usually faster to set up and grows as your sales grow, so it’s more flexible for short-term cash gaps.

Interest on loans covers the whole borrowed amount, but factoring fees are only based on the invoices you finance.

Invoice Factoring vs Overdrafts

An overdraft lets you spend more than your account balance, up to a set limit. You pay interest on what you’re overdrawn, and sometimes extra fees if you go over the limit.

Overdrafts are quick but need bank approval and regular reviews. The limit doesn’t automatically rise if your business grows.

Invoice factoring can offer more funding if you’ve got big invoice values. The facility grows with your sales, since more invoices mean more borrowing power.

Overdrafts don’t affect customer relationships, while factoring might, unless you use a confidential setup.

Costs, Benefits, and Considerations for SMEs

Invoice factoring can get cash into your business fast, but it’s not free. Costs, operational changes, and some risks come with the territory. Whether it’s worth it depends on your needs, your customers’ creditworthiness, and how you handle customer relationships and payment terms.

Typical Fees and Charges

Factoring fees usually run from 1% to 5% of the invoice value, depending on risk, invoice size, and payment terms. There might also be service fees for things like collections, credit checks, or admin—these could be monthly or per invoice.

For example, if you factor a £50,000 invoice at a 3% fee, you’ll pay £1,500, plus any service charges. Always check if fees come off upfront or at final settlement.

Other possible costs include:

• Set-up fees for opening the facility
• Minimum usage fees if invoice volume is below an agreed level
• Termination fees for ending the agreement early

It’s worth insisting on a clear, written fee schedule. That way, you won’t get caught out by surprise charges, and you’ll have a fair shot at comparing factoring with other borrowing options.

Impact on Cash Flow and Credit Control

A factoring facility can release up to 80–90% of invoice value within days. That quick access to cash boosts liquidity and means you might not need to lean so hard on overdrafts or short-term loans.

Since the factoring service usually handles payment collection, SMEs save time and avoid the hassle of chasing customers. For businesses that don’t have a finance team, that’s a real relief.

But here’s the thing: how the provider contacts your customers really matters. Some SMEs want a confidential setup, so clients never know about the factoring agreement.

Others are fine with open communication if it means invoices get paid faster. It’s all about what works best for your business style.

Factoring can make cash flow more predictable. That extra stability might help you negotiate with suppliers or grab bulk discounts when the opportunity pops up.

Still, it’s smart to keep an eye on debtor days. You want to make sure you’re really getting the most out of the facility.

Risks and Limitations

Invoice factoring depends on the creditworthiness of the SME’s customers—not just the SME. If customers tend to pay late, the provider might slash funding limits or hike up fees.

Getting into a factoring agreement can make an SME lean on that facility more than they intended. If the provider suddenly pulls the plug or tweaks the terms, cash flow could hit a rough patch.

Some contracts insist on factoring every invoice, which can feel a bit restrictive. It's worth checking if a selective or spot factoring option is even on the table.

There's also the reputation angle to consider. In certain industries, customers might see third-party collections and jump to conclusions about a company’s financial health—even if that’s totally off base.