What is invoice factoring and how does it work for UK businesses
Invoice factoring is a straightforward way to turn your unpaid invoices into cash quickly, without waiting for customers to pay. If you're a UK business struggling with cash flow because customers take 30, 60 or even 90 days to settle their bills, factoring could be the answer you're looking for.
What is invoice factoring?
Invoice factoring is a financial arrangement where you sell your unpaid invoices to a specialist lender, known as a factor. In exchange, you receive most of the money upfront, usually within 24 hours. The factor then collects payment directly from your customer when the invoice is due.
- You issue an invoice: your customer buys goods or services from you
- You sell that invoice: to the factoring company at a small discount
- You get paid immediately: typically 80-90% of the invoice value within one working day
- The factor collects from your customer: when the invoice falls due
- You receive the balance: minus the factor's fee, usually within a few days of payment
The key benefit is that you don't have to wait weeks or months for customer payments anymore.
How does factoring work in practice?
Let's walk through a real example to show how simple the process is in day-to-day practice.
- You deliver goods or services and raise an invoice as normal
- You submit the invoice to your factoring company
- The factor checks your customer's creditworthiness
- If approved, you receive 80-90% of the invoice value within 24 hours
- The factor sends payment collection instructions to your customer
- Your customer pays the factor directly on the due date
- You receive the balance minus the factoring fee
Most UK factors can process invoices within one working day, so you see cash in your account very quickly.
A practical example
You run a manufacturing business and supply components to a large retailer. You invoice them for £50,000 with 60-day payment terms. Rather than waiting 60 days, you factor that invoice on day one. The factor gives you £40,000 immediately (80% of the invoice value). When your customer pays the factor on day 60, you receive the remaining £9,500 minus the factor's fee (typically 1-3% of the invoice value, depending on your agreement). The factor keeps their fee as payment for the service.
The factoring process step-by-step
Here's exactly how the transaction flows:
Types of invoice factoring available
There are different flavours of factoring, each suited to different business needs. Understanding which type fits your situation is important.
Recourse factoring
With recourse factoring, if your customer doesn't pay the invoice, you have to buy it back from the factor. This is the most common type and typically the cheapest. It means you retain some credit risk, but the factor's fees are lower because their risk is reduced.
Non-recourse factoring
Non-recourse factoring means the factor bears the credit risk if your customer fails to pay. If the customer goes bust or simply won't pay, the factor absorbs the loss. This is more expensive because the factor is taking on more risk, but it offers you complete protection against bad debts.
Selective factoring
You don't have to factor all your invoices. Selective factoring lets you choose which invoices to factor and which to collect yourself. This is useful if you have a mix of customers with different payment terms or risk profiles.
Costs and fees explained
Factoring isn't free, but the costs are usually straightforward and transparent. Let's break down what you'll typically pay.
- Factoring fee: usually 1-3% of the invoice value, charged by the factor for their service
- Interest on the advance: sometimes charged if you take longer than expected to repay, though many factors include this in their flat fee
- Administration charges: some factors charge a small monthly fee for maintaining your account
- Credit insurance: non-recourse factoring includes credit insurance, which costs more but protects you against customer defaults
The total cost depends on your invoice size, customer creditworthiness, and the type of factoring you choose.
Who should consider invoice factoring?
Factoring works best for certain types of businesses. Check whether your situation fits.
- You have B2B customers (not consumer sales) who take 30+ days to pay
- You need cash to pay staff, suppliers or overheads before customers pay you
- Your business is growing and you lack working capital to support that growth
- You've been rejected for bank loans or overdrafts
- You want to reduce time spent chasing late payments
- You operate in industries like manufacturing, logistics, recruitment or construction
If you tick most of these boxes, factoring could seriously improve your cash flow.
Advantages and disadvantages
Like any financial product, factoring has pros and cons. It's worth considering both sides before deciding.
The advantages
Factoring provides immediate cash flow, reduces admin burden, improves your ability to take on new business, and protects you (if you choose non-recourse) against bad debts. It's also faster and easier to arrange than bank loans for many businesses.
The disadvantages
Factoring costs money (1-3% per invoice), your customers will know you're using a factor (they'll see the factor collecting payment), and you lose some control over the customer relationship. Some business owners also worry about the perception that factoring signals financial difficulty, though this is becoming less of an issue as more businesses use it.
Key regulations in the UK
Invoice factoring in the UK is regulated by the Financial Conduct Authority (FCA). When you choose a factoring company, make sure they're FCA-authorised. Reputable factors are often members of the National Association of Commercial Finance Brokers (NACFB), which sets professional standards for the industry.
- All FCA-regulated factors must follow strict consumer protection rules
- Your contract should clearly set out all fees, terms and conditions
- You have the right to cancel within 14 days under consumer law (if you're a small business)
- Factors should explain how your customer data will be handled
- The FCA maintains a register of all authorised firms at register.fca.org.uk
Always check that your factoring company is FCA-regulated before signing any agreement.
How Spark Finance can help
At Spark Finance, we're an FCA-authorised business finance broker. We work with over 100 specialist lenders and factors across the UK, so we can find the right factoring solution for your business.
- We compare factoring deals from multiple providers so you get the best rates and terms
- We handle all the paperwork and negotiation on your behalf
- We offer a free, no-obligation eligibility check to see if factoring is right for you
- We don't carry out a credit check at the initial assessment stage, so there's no impact on your credit file
- Our team understands the needs of UK business owners and can explain everything in plain English
Get in touch with us today for a free chat about whether invoice factoring could solve your cash flow problem.
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Frequently asked questions
Will my customers know I'm using invoice factoring?
Yes, your customers will know because the factor sends them payment collection instructions and they'll pay the factor directly rather than you. However, factoring is now common across many industries, and most established businesses use it at some point. It's not generally seen as a sign of financial trouble.
How quickly will I get the money?
Most UK factors will pay you within 24 hours of approving and receiving your invoice. Some offer same-day payment for invoices submitted early in the morning. The factor's credit check on your customer usually takes a few hours.
What happens if my customer doesn't pay the factor?
If you have recourse factoring, you're responsible for buying the invoice back or refunding the advance to the factor. With non-recourse factoring, the factor absorbs the loss. This is why non-recourse costs more, as the factor is taking on the credit risk.
Can I factor invoices from new customers?
Yes, you can, but the factor will carry out a credit check on the new customer to assess their payment risk. If the customer has no credit history or poor payment history, the factor may decline to factor those invoices or charge a higher fee.
Important information: Spark Finance Limited is authorised and regulated by the Financial Conduct Authority (FRN 958123). We are a credit broker, not a lender. This guide is for informational purposes only and does not constitute financial advice. Think carefully before securing debts against property or assets. Your business may be at risk if you do not keep up repayments on a debt or other commitment entered into in relation to it.