Should you choose invoice finance for the cash you need?

If you’re considering your options for financing your small business, you’re bound to come across the term ‘invoice finance’.

You may also hear about ‘factoring’ and ‘accounts receivable finance’.

What you might not realise is that these are all names for the same type of business finance.

If you’re wondering what it actually is – and whether it could be good choice for your business – this article is for you.

I’ll take you through how invoice finance works, how to go about getting it, and why it’s a very popular option for many Australian SMEs. And I’ll also cover the drawbacks – because there are always drawbacks! – to help you decide if it’s a financing option you want to consider.

Ok, so let’s start with the basics.

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What is invoice finance?

Invoice finance is a form of short-term business finance.

The most important thing you need to know about it – and one of the reasons it’s so popular – is that it doesn’t involve borrowing.

That’s right – it’s a way of financing your business without taking on debt.

That’s actually a bit misleading though – because, unlike other forms of finance (like a loan or an equity injection) it won’t actually put more funds at your disposal. What invoice finance does is let you access the proceeds from your sales more quickly.

Let me explain.

When you sell to a customer on credit terms, you may have to wait 30, 60 or 90 days for them to pay your invoice. In the meantime, that invoice is an asset on your balance sheet – but it’s no use to you when it comes to paying your bills.

Invoice finance lets you cash in that asset and get your hands on the funds right away, by selling your unpaid invoice to a third party. That third party – your invoice finance / factoring company – will give you anywhere from 70 to 90 per cent of the invoice value up front.

Factoring Diagram Illustration

At this point you’re probably thinking:

“But what about the other 10 – 30 percent?”

Good question.

When the invoice finally falls due, the factoring company will collect payment from your customer in your place. Once they receive the money, they’ll deduct a fee for their service, then send the rest on to you.

For example

Step 1: You issue an invoice for $2000 to your customer on 30-day terms

Step 2: You sell the invoice to a factoring company and receive an 80% advance of $1600

Step 3: After 30 days your factoring company collects $2000 from your customer

Step 4: The factoring company deducts a 2.5% fee and transfers the balance of $350 to you

Outcome: you have paid $50 to receive $1600 of your invoice 30 days sooner.

By now you might be wondering why anyone uses invoice finance.

After all, the unpaid invoice is money you’ve worked hard to earn, and it’s coming to you anyway. Factoring won’t give you any extra money to invest in your business, and you’ll probably end up using it in exactly the same way you would if you received it direct from the customer.

So why would you pay someone else to give you what’s already yours?

There are some pretty good reasons, actually.

Why would a business use invoice finance?

I can sum up the main reason in two words. Cash flow.

Cash Flow Example

As a small business owner, I’m sure you already know that cash is KING. It really doesn’t matter how much you sell, or how profitable you are on paper, if you can’t pay your bills when you need to.

Your accounts receivable may be a lovely, sizable asset on your balance sheet, but that’s going to be of no interest at all to your suppliers.

You’re probably well aware that running out of cash is the most common reason for business failure – not just here in Australia but all over the world – so it’s absolutely vital that you keep your cash flowing at all times. And that’s where invoice financing comes in.

Business Cash-Flow Australia Diagram

OF course, if you operate a payment-on-sale type of business, invoice finance won’t be of any use to you at all. You’ll only be able to use it as a financing option if you have unpaid invoices to sell.

But if yours is an industry where customers expect credit terms – or where you can get a competitive edge by offering them – you’ll have to find a way to cover all your costs at the time you make the sale, even though you won’t receive payment for ages.

By turning to invoice finance, you can eliminate the timing gap that can make it so hard for a small business to stay afloat – and you won’t have the worry of being caught short if you’re relying on receiving the cash but your customers are slow with their payments.

The other advantage of invoice factoring is that you won’t have the hassle of collecting debts. Chasing debtors can be stressful and time consuming, and if you don’t have the time, or the skills within your team, you might appreciate the chance to outsource the whole process to your factoring company!

(Having said that, the invoice may actually end up back on your desk if the customer refuses to pay – but I’ll get to that in a moment).

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Who uses invoice finance?

As I mentioned, only businesses that make sales on credit terms can use invoice finance.

Of those, it’s mostly popular with businesses that either:

  • Don’t want to take on debt finance just to help them manage their cash flow (so they’ll have more capacity to apply for a loan at a later stage if they need one to finance growth)


  • Don’t qualify for an affordable business loan – maybe because they have a poor credit rating, or because they haven’t been in business for long enough.

    The thing about invoice finance is that the lender isn’t taking a risk on your business, but on how likely your customers are to pay their bills. So, if you’re new on the block but have creditworthy, reliable customers, you may find it far easier and far less expensive to get invoice finance than any type of business loan.

Lender Investigate Customer Illustration

So now you know why you might want to use invoice finance, I’m guessing your next question might be:

How much will invoice finance cost?

I‘m sorry to say that invoice finance is generally a pretty expensive option, especially if you offer credit terms of 60 or even 90 days. You’ll generally pay a fee per 30 days the invoice is outstanding, so using the example I gave you above, you’d pay $150 to factor the $2,000 invoice for 90 days (3 x the 2.5% fee).

Invoice Finance Cost Table

In that example I used a 2.5% factoring fee, but rates of anywhere from 1.5% up to a hefty 4.5% are common. Other than the length of time until the invoice is due, there are a few factors that will impact the cost:

  • How creditworthy (i.e. risky) your customers are – the better their credit record and history of timely payment, the less you can expect to pay for your invoice finance.

  • Whether you choose recourse or non-recourse factoring.

    If you’re wondering what that means, it’s all about what happens if your customer fails to pay their invoice when it’s due.

    • With non-recourse factoring, the debt is the factoring company’s problem. It’s up to them to collect payment. If they can’t, you’ll never receive the residual balance payment (the 10 – 30 perfect less factoring fee) but you won’t have to repay the advance.

      Non-Recourse Factoring Diagram
    • With recourse factoring, your lender can force you to buy back the invoice if they can’t collect payment, and it will be up to you to pursue the customer or write off the bad debt.

      Recourse Factoring Diagram

    As you can imagine, lenders will charge you more for non-recourse factoring, if they’re willing to offer it to you at all.

  • Whether you opt for ‘spot’ or ‘whole ledger’ factoring.

    This is all about flexibility. Ideally, you’ll want to be able to access fast cash when you need it, but only when you need it (“spot factoring”). You don’t want to be locked into an expensive financing arrangement that forces you to pay for the service even when your cash flow is strong and healthy.

    Factoring companies, on the other hand, want a steady flow of reliable income. They may only be prepared to offer you a ‘whole ledger’ arrangement, where you have to sell all your invoices for an agreed period – or all invoices for specific customers (the ones with the best credit ratings, of course! In fact, even with whole ledger factoring you may find they’ll only agree to buy invoices for certain customers – or charge higher rates for the less financially stable customers.)

    To get the flexibility to factor only when you need to, you’ll probably have to pay a higher fee per invoice – but you’ll pay less overall, of course, if you only sell a few invoices.

Spot Factoring Diagram

Spot Factoring Diagram

Whole Ledger Diagram

Whole-ledger Factoring Diagram

So far, I’ve only been talking about the factoring fee, which will generally be a percentage of the invoice you’re selling. But, as with most forms of business finance, you’ll probably have to pay other costs too.

You may be charged a set-up or facility fee, monthly or annual administration fees, and perhaps also transaction or transfer fees per invoice. When you’re comparing your options, be sure to find out about all the fees and costs, because these can add up and make a big difference if you’re using the service a lot.

Right, now that we’ve covered ‘why’ and ‘how much’, your next question is probably ‘where’ (and how), to get invoice finance.

But before I move on to that, let’s take a quick look at the potential pitfalls.

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Three major drawbacks to invoice finance

There are three issues you need to think about before applying for invoice finance.


The first is the point I’ve already touched on – invoice factoring does not give you any extra cash to invest in your business. In fact, it will leave you with less cash overall, because the factoring fees will eat into your profits. Its purpose is to accelerate your income so you can cover gaps in working capital.

That can be incredibly useful, of course, but you definitely can’t use it to finance big investments or long-term opportunities. After all, if you divert that income to buying a major asset, how will you fund your regular expenses for the next few months?


The big problem with accelerating cash flows is that you can lock yourself into a cycle where you can’t afford to stop. After all, if you’ve received all next month’s income in advance, then you stop factoring, you’ll have to go two months with no money coming in. Can you afford that, or could it drive you into an even bigger cash flow crisis than the one you used factoring to avoid?


The final pitfall concerns your reputation. These days, customer satisfaction couldn’t be more important. Word spreads like wildfire on social media, so a mistake could cost you not just one customer, but several.

Social Media Impact Illustration

When you engage a factoring company, you hand a key part of your customer relationship to a third party. And don’t forget that factoring companies will be most interested in your most creditworthy customers – the ones that are probably your most valued clients.

But what happens if your customer is a day or two late making payment – will the factoring company respect how important they are to you? Will they take steps to preserve the relationship – or will they aggressively pursue payment and potentially alienate the very people your business depends on?

Debt Collector Scold Customer Illustration

Even if your customers don’t have a bad experience at the hands of your factoring company, the arrangement will still be very public. Since the finance company will contact them to collect payment, your customers will know that you are relying on finance to manage your working capital – which may make them feel concerned about your financial stability and less comfortable about doing business with you.

Having said all that, invoice finance definitely has its place and can be a very useful tool. It’s a good idea to chat to your financial advisor before making any decisions, to work out if it’s the right option for your business.

If you decide that it is, then you’ll want to know:

Where to go to get invoice finance

A quick Google search will show you that invoice finance is very easy to come by.

You could turn to your usual bank, as most high street banks and building societies offer the service. But these traditional lenders generally have strict criteria about which small businesses they’ll deal with, and the application process could be slow and paperwork-heavy.

Bank Slow Process Illustration Illustration

Another option is to turn to the FinTech market. You’ll find there are scores of alternative lenders who offer factoring as one of their services (along with debt finance products like unsecured loans or merchant cash advances) – and several who specialise in invoice finance.

Some of these companies will happily consider applications from any SME, while others work only with particular industries (e.g. factoring of real estate commissions).

You’ll need to choose your provider with some care.

  • Firstly, there are the costs, which can vary widely. Look at the percentage of the invoice you’ll get as an advance (as I said, this could be anywhere from 70 – 90 percent) and the percentage you’ll pay as a fee (commonly 1.5 – 4.5 percent) – and don’t forget to look for the extra costs, including any hidden ones.

  • Then there are the terms. You may find that not all providers are willing to offer you spot factoring or a non-recourse arrangement, so if this is what you want, you may need to look around.

  • You need to know that while high street banks and buildings societies are tightly regulated in Australia, alternative finance providers don’t yet have to follow the same strict rules. So you need to make sure you’re dealing with a company that has a solid reputation – and watch out for any unfavourable conditions, like expensive termination fees if you decide to end your financing arrangement.

  • While we’re on the subject of reputation, remember that these people will be dealing with your customers, and they could do you a lot of harm if they don’t treat them well. Ask for recommendations from your networks and do some research online (social media is a great place to look for customer feedback) to find out how they conduct themselves, and if they use any negative tactics that could send your precious customers running to your competitors.

Once you’ve chosen a provider you’re happy with, you’re almost there.

The final step is to put in your application.

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How to apply for invoice finance

Apply Online Illustration

In most cases, applying for invoice finance is quick and easy – especially if you’ve chosen an alternative lender.

The first time you apply for factoring you’ll have to prove your identity and share important details about your company and your customers. You’ll probably have to fill out an online application form and upload supporting documents such as your accounts receivable ledger and your customer payment history (an ‘aging report’).

The lender will assess your application and, if you’re successful, let you know once your facility has been set up. They’ll confirm which customers they’re willing to factor and the terms and conditions (fees, recourse or non-recourse, spot or whole ledger) and then you’ll be ready to start factoring.

Once the service is up and running, you’ll usually be able to upload invoices whenever you need to, and get an almost instant cash advance.


Invoice factoring is a very popular financing option because it’s quick and easy to access, even for companies that don’t qualify for a business loan. It is only a short-term option, and it won’t inject any extra cash into your business because you won’t actually be borrowing any funds. Instead, you’ll get quicker access to the money you’ve earned from customer sales.

That makes invoice finance a very useful tool for managing cash flow and covering the gap between sale and payment. It can also help you attract customers, by allowing you to offer credit terms that you might not otherwise be able to afford.

But it does come at a cost.

That cost may not just be financial – as well as eating into your profits, it could damage your relationship with customers and ultimately cost you important business relationships.

If you’re considering using invoice finance, make sure you understand all the options I’ve covered in this article, and be sure to shop around and get some recommendations before you lock your business into any contracts.

Have you used invoice factoring in your business? Would you recommend it to other small business owners? Please let us know in the comments below.

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