Is Invoice Finance Appropriate for Micro-Businesses?


Business InvoiceLate payments are one of the biggest challenges micro-businesses face when it comes to growth. Delayed payments can threaten micro-firms’ ability to trade, stifle their appetite for recruitment and in the worst cases, even lead to insolvency. (Take this insolvency test now if you’re not sure)

A recent survey of 250 micro-businesses, classed as businesses with one to 10 employees, found that they were spending an average of 19 days a year chasing invoices and 32 percent had accessed credit to pay suppliers and wages.

Micro-businesses account for 96 percent of all UK firms and are owed an estimated £16.9bn in outstanding payments. Yet despite playing such a central part in the UK economy, many larger businesses and even public sector organisations fail to pay micro-businesses on time.

Is invoice finance the answer?

Invoice finance can turn invoices into cash in as little as 24 hours. The first step is to contact an invoice finance provider to put an arrangement in place. Firms then send copies of invoices issued to their commercial customers to the finance provider. They will pay anything from 80-95 percent of the value of the invoice upfront. Once the customer finally pays the invoice, the balance is paid to the business minus the finance provider’s fee.

Clearly, this form of finance can be an effective way to mitigate the impact of late payments. Rather than waiting 30, 60 or even 90 days for payment, micro-firms have the funds they need to pay creditors and employees, buy raw materials and capitalise on new opportunities that come along. That’s why there has been such a dramatic rise in the number of small businesses using invoice finance over the last few years.

Is invoice finance suitable for micro-businesses?

Invoice finance is an umbrella term for a number of different products, not all of which can be accessed by micro-firms.

  • Invoice factoringInvoice factoring is the most likely option for micro-businesses. That’s because the responsibility for collecting payments from customers moves to the finance provider. That makes the process less risky for the factor, which means they are more likely to agree to work with smaller businesses. Not every invoice provider will work with micro-businesses, but the increase in competition in the sector means there are specialists that finance smaller amounts.
  • Invoice discounting – This is unlikely to be an option for micro-businesses because the collection of the debt rests with the firm. That gives the lender less control, which means they typically only work with firms with a turnover of £100,000+ and a positive net worth on their balance sheet.

While invoice factoring might be available to many micro-businesses, the fact that invoice factoring is a whole-ledger agreement (applies to every invoice the firm issues) makes many businesses think twice. For many micro-firms, raising finance against every invoice will reduce their profit margins by an unacceptable amount. But there is an alternative…

  • Spot factoring – Spot factoring or ‘single-invoice factoring’ allows businesses to factor a single invoice without entering into a long-term agreement or committing to factor a minimum monthly or yearly amount. However, with spot factoring, the factor sets a minimum invoice amount as they are only guaranteed one transaction. That means it will need to be larger invoices that are factored.

What are the potential drawbacks?

Invoice factoring, whether it’s a whole ledger or single invoice agreement, can be very appealing, but as with any source of business finance, there are certain drawbacks and limitations. That includes:

  • Profitability will take a hit – The fees associated with invoice factoring mean the profit margin will be reduced on the products or services you sell.
  • Only business-to-business invoices apply – The vast majority of invoice finance providers only fund commercial invoices. If you sell directly to consumers then it’s unlikely you’ll find a financier.
  • Customers may prefer to deal with you directly – The factor will assume responsibility for collecting payments from customers. That means your customers will be aware you’re using a third-party financer and your relationships could be affected.

The biggest hurdle micro-businesses face when trying to secure an invoice finance agreement is the minimum annual turnover amount finance providers commonly apply. However, there are now more than 50 invoice finance firms in the UK, giving you a greater chance of finding the right match for your micro-business.