What are the costs of invoice factoring and is it worth it for your business?

If you’re waiting weeks or months for customers to pay their invoices, you’re not alone. Around 44% of invoices are paid late, say small UK businesses. And they’re collectively owed £112 billion from outstanding invoices – £42,000 each, on average.

Invoice factoring could help solve this cash flow problem. But like any financing solution, it comes with costs that you’ll need to consider along with the potential benefits.

In this article, we’ll explain what invoice factoring costs, help you decide if it’s worth it for your business, and show you how to choose the right provider.

Key points:

• Invoice factoring typically costs 0.5-3% of your invoice value plus setup and interest fees, but provides immediate cash flow

• For businesses struggling with late payments or rapid growth, invoice factoring can provide crucial liquidity and free up time spent chasing payments

• Funding Options by Tide can help when optimisation of working capital isn’t enough, offering access to business finance up to £20 million

How does invoice factoring work?

Invoice factoring is essentially selling your unpaid invoices to a finance company in exchange for immediate cash.

Instead of waiting 30, 60, or even 90 days for customers to pay, you could get most of that money within 24-48 hours using invoice factoring.

Here's how it works in practice:

• You deliver goods or services to your customer and send them an invoice as usual

• But instead of waiting for payment, you sell that invoice to a factoring company who will advance you around 80-95% of the invoice value almost immediately

• Your customer then pays the factoring company directly

• Once the factoring company receives the full payment, they’ll send you the remaining balance minus their fees

• The factoring company also handles the credit control process, including chasing late payments and managing your accounts receivable

There are two main types of factoring to be aware of:

• Recourse factoring: You’re still responsible if your customer doesn’t pay (you’ll need to buy back the unpaid invoice or replace it with another)

• Non-recourse factoring: The risk is transferred to the factoring company, but it typically costs more

How much does invoice factoring cost?

Invoice factoring costs can vary depending on your business, customers, and the provider you choose. But you can roughly expect the following charges:

Main charges:

• Service fee: Usually 0.5-3% of the invoice value (occasionally up to 5% for higher-risk sectors)

• Discount rate: 1.5-5% per annum on advanced funds (usually charged as interest for the time the advance is outstanding, and may be calculated daily or monthly)

• Setup fee: 1-2% of the facility limit (not all providers charge this)

• Admin fees: Varies by provider and sometimes wrapped up in the service fee

Other potential costs:

• Credit check fees: May be charged for assessing the reliability of your customers

• Collection fees: Extra charges if invoices need chasing

• Termination fees: Penalties if you exit the contract early

• Renewal fees: A yearly facility review charge

When you add it all up, UK businesses typically pay around 1-5% of an invoice’s value in total factoring costs, depending on the structure of the deal.

Use our invoice finance calculator to get an instant estimate based on your invoice values and payment terms.

Example

Let’s say you factor a £10,000 invoice with 30-day payment terms. The factoring company advances you 85% (£8,500) immediately. They charge a 1% service fee (£100) and a 2.5% annual discount rate. The discount rate works out to about £17 for the 30-day period (2.5% ÷ 365 days × 30 days × £8,500).

Your total cost would be around £117, and you’d receive £9,883 once your customer pays.

The exact cost would depend on several factors, however. Clients that provide a higher volume of invoices typically get more competitive rates, as do businesses with reliable, creditworthy customers. Your industry matters too – sectors like recruitment often get offered lower interest rates because they’re considered lower risk.

Are the costs of invoice factoring worth it?

Whether factoring costs are worth it depends on your specific situation. But for some businesses dealing with cash flow challenges, the benefits can outweigh the costs.

Let’s start with the benefits…

The most obvious benefit is immediate cash flow. If you’re struggling to pay suppliers, staff, or rent because customers are paying late, factoring could provide the working capital you need to keep operating.

You could also save time on credit control. Chasing late payments can take hours each week – hours that could be better spent growing your business. Some business owners find that outsourcing this to a factoring company can help improve their customer relationships, since professional collection teams often get better results.

But there are some downsides to consider…

The fees will reduce your profit margins, so you may want to factor this into your pricing strategy. Some customers might also view factoring as a sign of financial weakness, although this perception seems to be changing as more businesses use it.

There’s also the commitment aspect. Most factoring agreements require you to factor all invoices from selected customers, and contracts typically last for 12 months or more. So you can’t just dip in and out when it suits you.

The key question to consider is whether the cost of factoring is less than the cost of not having immediate cash. For example, if late payments are stopping you from taking on new work, causing you to miss early payment supplier discounts, or forcing you to turn down opportunities, then factoring could be a worthwhile investment.

How do invoice factoring costs compare to other options?

Before committing to invoice factoring, it’s worth understanding how it stacks up against other financing options:

Invoice factoring vs. invoice discounting

• Control: Invoice discounting lets you maintain customer relationships and credit control

• Cost: Discounting is typically cheaper as you handle collections yourself

• Confidentiality: Customers don’t know about discounting arrangements

• Requirements: Discounting usually needs higher turnover and better credit control systems

Invoice factoring vs. business loans

• Speed: Factoring is much faster (24-48 hours vs. weeks for business loans)

• Qualification: Based on customer creditworthiness, not just your credit history

• Cost: Often more expensive than bank loans but comparable to short-term finance

• Flexibility: Scales with your sales, unlike fixed loan amounts

Invoice factoring vs. overdrafts

• Limits: Factoring can provide higher amounts based on invoice values

• Approval: Easier to qualify for factoring than large overdrafts

• Structure: Factoring fees are predictable, overdraft rates can be variable

• Purpose: Overdrafts for short-term gaps, factoring for ongoing cash flow management

Which option’s right for your business will depend on your priorities. If you need speed and want to outsource credit control, factoring could be a suitable option. But if you want to maintain customer relationships and have strong internal systems, invoice discounting could be the right choice. And if you need large amounts at low rates and can wait, a traditional business loan could work well.

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Checking if you’re eligible is free, only takes a few minutes, and while a full application would impact your personal or business credit score, checking eligibility won’t. Just submit your details via the link below to find out if you could be eligible to borrow up to £20 million.

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FAQs

How much should I expect to pay for invoice factoring?

Most UK businesses pay a factoring fee (sometimes called a discount or service fee) between 0.5%-3% of each invoice’s value, plus a discount rate of 1.5-5% each year on the funds advanced. The exact cost depends on your industry, invoice volumes, customer quality, and the provider you choose. Higher-volume businesses with creditworthy customers typically get better rates.

What’s the most expensive part of invoice factoring?

The service fee is usually the most expensive part of invoice factoring, typically ranging from 0.5-3% of your invoice value. Some providers also charge a discount rate, which is an interest rate on the funds advanced – usually 1.5%-5% per year (sometimes quoted as a monthly or daily rate).

Are there any hidden costs I should know about?

Possibly, depending on the provider. Look out for application fees, setup fees, customer credit check fees, collection charges, early termination fees, and annual renewal fees. Some providers are more transparent than others, so always ask for a full breakdown before signing up.

Is invoice factoring more expensive than a bank loan?

Invoice factoring can be more expensive than traditional bank loans in terms of percentage costs. But factoring can be faster to arrange, more flexible, and easier to qualify for, especially if your business struggles to secure bank finance.

How can I reduce my invoice factoring costs?

You could reduce your invoice factoring costs by:

• Factoring larger or more invoices

• Working with reliable, creditworthy customers

• Maintaining a track record with your provider

• Shopping around and negotiating

• Encouraging early payments from your clients

• Being a larger businesses (they often get better rates, but volume discounts can also be available for SMEs)

What makes invoice factoring worth the cost?

Invoice factoring could be worth it if the benefit of immediate cash outweighs the fees. For example, if late payments prevent you from growing, buying stock, or paying your own bills. Also, the time and effort saved on credit control can be worthwhile in and of itself.

Is my business too small for invoice factoring to be cost-effective?

Not necessarily. Many providers work with smaller businesses and startups, but there’s typically a minimum turnover requirement and minimum invoice value (often £1,000-£5,000 per invoice)

When is invoice factoring not worth the cost?

Invoice factoring may not be worth the cost if:

• Customers pay quickly (within 7-14 days)

• Your margins are very slim

• You mostly bill consumers rather than other businesses

• Your average invoice sizes are small

Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

Funding Options, now part of Tide, helps UK firms access business finance, working directly with businesses and their trusted advisors. Funding Options are a credit broker and do not provide loans directly. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Funding Options can introduce applicants to a number of providers based on the applicants' circumstances and creditworthiness. Funding Options will receive a commission or finder’s fee for effecting such finance introductions.