For small and medium-sized enterprises (SMEs), funding is often the lifeblood of day-to-day operations and long-term growth. Whether you are seeking to finance expansion, manage cash flow fluctuations, or simply to keep your business going during challenging periods, choosing the right funding solution can be pivotal. Two popular options available to SMEs are invoice finance and business loans. Yet, the decision between these can be nuanced, dependent on your business’s unique circumstances, needs, and objectives.
It can be easy to settle for the easy option and take on a business loan however this may not be the right solution and could restrict the growth of your business. Having a comparison solution is sensible and invoice finance is a popular alternative which is more flexible than a business loan and will grow as your business grows.
What is Invoice Finance?
Invoice finance is an umbrella term for financial solutions that allow businesses to unlock cash tied up in unpaid invoices. Instead of waiting for customers to pay, you can access a percentage of the invoice’s value—typically between 70% and 90%—almost immediately. The finance provider can then collect payment from your customers (in the case of factoring) or you continue collections yourself (in the case of invoice discounting).
Types of Invoice Finance
There are a few types of invoice finance products that could be available to you:
- Factoring: The invoice financier will provide funding and manage your sales ledger whilst collecting payments directly from your customers.
- Invoice Discounting: Alongside your funding facility, you maintain control over your sales ledger and collections
- Selective Invoice Finance: You choose which customers to finance, offering flexibility and control over costs.
The advantages of Invoice Finance
There are many advantages of using invoice finance:
- Improved Cash Flow: Immediate access to funds improves working capital, allowing you to reinvest in operations, pay suppliers, or manage payroll without delays.
- Flexibility: You can use the funds for any business purpose—investment, expansion, working capital, asset purchase, or even refinancing.
- Sales Growth: With more predictable cash flow, you can confidently take on bigger clients or larger contracts without worrying about extended payment terms.
- Not Secured Against Assets: Typically, invoice finance is secured against your debtor ledger, not physical company assets like property or machinery.
- Scalable Solution: As your sales grow, the amount of available funding increases, directly linked to your revenue with no renegotiating or facility amendment fees
- Outsourcing Collections: Factoring can reduce administrative burden and the costs associated with chasing late payments – allowing you to use resources more productively.
Things to consider
When taking on an invoice finance solution you need to consider the following:
- Not suitable for all businesses: Businesses who do not sell on credit or have few credit sales are not suitable as funding is based on your sales invoices.
- Cost: Fees can be higher than a business loan, but the flexibility of available funding can mean you have access to increased funds as the size of your funding facility is based on your current sales not historical performance. You may also be benefitting from outsourcing your sales ledger management and collections allowing you to use your internal resource driving your business forward.
- Perceived loss of control (Factoring): You may be concerned about losing control over customer relationships if the finance provider manages collections. A recourse facility means that the invoice financier works with you and will gain approval on how they work with slow or non-paying customers. Non-recourse facilities give the invoice financier complete control on what processes they implement.
- Eligibility Criteria: Invoice Financiers often require you to have creditworthy customers and a track record of trading although it should be remembered that they make their funding decisions on the merit of the customer invoice.
- Customer Perception: A historic view is that businesses who use Invoice Finance may not be financially stable. However, over the past decade, this view is fast eroding due to the flexibility of the solution and the close relationship with the funder.
What is a Business Loan?
A business loan is a lump sum provided by a bank, repaid over an agreed period with interest. Loans can be secured – against your assets – or unsecured – where no collateral is required, but often at higher interest rates.
Types of Business Loans
There are a few types of invoice finance products that could be available to you:
- Bank Loans: A traditional solution, often with competitive rates for creditworthy businesses but can be harder to secure.
- Alternative Lender Loans: Offered by online lenders or specialist finance companies, usually with faster approval but higher costs.
- Secured Loans: These loans are backed by business or personal assets, generally with lower interest rates.
- Unsecured Loans: No collateral is required, but higher rates and stricter eligibility criteria will apply.
- Government-Backed Loans: Schemes like the UK’s Start Up Loans or Recovery Loan Scheme may offer preferential terms for SMEs.
The advantages of Business Loans
There are many advantages of business loans:
- Flexibility: You can use the funds for any business purpose—investment, expansion, working capital, asset purchase, or even refinancing.
- Predictability: Repayments are usually fixed over an agreed period, allowing for easier budgeting and financial planning.
- No Customer Involvement: Loans do not affect client relationships or require customer awareness.
- Potentially Lower Costs: For businesses with strong credit, loans can be cheaper than invoice finance (invoice discounting) but do not provide you with any credit worthiness information on your customers.
- Longer Terms: Loans can be structured over several years, suitable for long-term projects or purchases.
Things to consider
When taking on a business loan you need to consider the following:
- Eligibility and Security: Secured loans require assets as collateral, putting those assets at risk. Unsecured loans may be difficult for newer or smaller businesses to obtain.
- Rigid structure: Repayments are fixed regardless of your business’s income, which can be challenging during slow periods.
- Potentially Slow Approval: Banks may take weeks to process and approve a loan.
- Balance sheet funding: A business loan adds to your business’s liabilities and appears on your balance sheet, which can affect future borrowing and business valuation.
- Credit Impact: If you default on your scheduled loan payments this will negatively impact your business’s credit rating.
Comparing invoice finance and business loans?
When making the decision as to which solution is right for your business you need to consider what is important to you:
Speed of Access
Invoice finance is typically faster to set up. Some facilities can be arranged within days. Loans, particularly those from banks, may take longer due to due diligence, credit checks, and paperwork.
Cash Flow Impact
Invoice finance grows as your sales grow, so it can be more flexible for businesses with fluctuating cash needs. Loans provide a fixed cash injection but do not adjust to your future sales, potentially leading to cash shortfalls if sales spike or decline unexpectedly.
Security and Risk
Invoice finance is usually secured against your debtor ledger, not assets. Loans may require assets as collateral, putting property or equipment at risk if you default. Unsecured loans avoid this but will have higher costs and stricter requirements.
Customer Relationships
Factoring may involve the funder contacting your customers directly, which may affect the client relationship. It is important that you understand how the funder collects payment and what happens in the instance of late or non-payment. Invoice discounting and business loans are generally confidential.
Suitability by Business Stage
- Startups: May struggle to secure a loan, but invoice finance is possible if you have invoices from credible customers.
- Growing Businesses: Invoice finance offers flexibility and scalability; loans can fund larger projects or one off acquisitions.
- Mature Businesses: May use both, depending on cash flow cycles and capital needs.
Eligibility
Loans and invoice finance can both require proof of trading history and, often, creditworthy customers. Startups may find it challenging to secure a loan, but invoice finance may be more accessible if you have regular sales on credit terms.
Cost Comparison
Invoice finance has two fees: firstly, the cost of funding – usually a percentage of your turnover – and you only pay for what you use. Secondly a service fee which will be higher for factoring as they are managing your sales ledger and collections often offsetting internal costs. Additionally, there may be an arrangement fee.
Business loans come with interest rates and potentially arrangement, early repayment fees or renegotiation fees. The total cost will depend on the facility size, your business’s risk profile, and the lender’s terms.
Which solution is right for you?
It’s important that you take the time to consider which solution is right for you and not take the easy option. The right choice may depend on your business model, cash flow needs, relationships with customers, and risk appetite.
To help you decide you should ask yourself:
- Do you regularly issue invoices with long payment terms to reliable customers?
- Is cash flow management a daily challenge?
- Would you benefit from outsourcing credit control?
- Do you need a lump sum for a specific investment, or ongoing funding as you grow?
- Are you comfortable pledging assets as security, or would you prefer a facility secured against your receivables?
If your main challenge is waiting for invoices to be paid, invoice finance may be the ideal solution as it turns unpaid invoices into a flexible source of working capital. It will also provide an upfront lump sum based on the amount of unpaid invoice payments at the outset, enabling you to use this for investment or acquisition.
However, if you require a fixed amount of funding for a one-off investment, expansion, or acquisition, and have the means to meet regular repayments, a business loan could be more appropriate.
Practical steps before deciding
- Carefully review your business’s cash flow cycle, payment terms, and customer base.
- Calculate the true cost of both options by considering all fees, interest rates, and additional charges.
- Assess your asset base and willingness to provide security, as well as your credit rating and trading history.
- Consider the impact on customer relationships and administrative workload.
- Seek advice from an independent business finance adviser or accountant before making a commitment.
In summary
There is no universal answer to the question of whether invoice finance or a business loan is best for every SME. Invoice finance is agile and grows with your sales, ideal for businesses dealing with late-paying customers or seasonal demand. It provides ongoing cashflow support. Loans provide a predictable solution for one-off funding needs. By evaluating both the needs and strengths of your business, and by seeking independent advice where necessary, you can secure the funding that best supports your business’s requirements and ambitions.
Link to further reading
Why UK businesses should choose Invoice Finance.
