What is invoice finance?
Invoice finance is an increasingly common form of short-term borrowing, often used to improve a company’s working capital and cash flow position. There are two main types of invoice finance- ‘discounting’ & ‘factoring’.

Invoice discounting and factoring allow a business to draw money against its sales invoices before the customer has actually paid. To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as security for the borrowing.

Factoring’ – also known as ‘debt factoring’ – usually involves an invoice financier managing your sales ledger and collecting money owed by your customers themselves. This means your customers will know you’re using invoice finance.

With ‘invoice discounting’, the invoice financier won’t manage your sales ledger or collect debts on your behalf. You’ll still be responsible for collecting debts if you use invoice discounting, but it can be arranged confidentially so your customers won’t find out.


How does it work?

Despite the popularity, and simplicity of both types of invoice finance, many business owners expect the admin involved to be more time consuming and complicated than it actually is, and in my experience book-keepers and accounts, who are new to invoice finance often struggle with making the correct accounting entries. The below explains how to deal with both.

Admin process

1. When you raise an invoice, you will need to send the details to your finance provider. Usually this is done by pulling a sales day book, or list of invoices from your accounting system at the end of each day or week. You will then need to upload these onto an online account, which your provider will set up for you

2. They will then make a percentage of the invoices (usually around 80%) available to you upfront. This will appear as available funds on your on-line account, which you will be able to withdraw whenever you wish

3. Your customer will then need to pay directly into a trust account which the provider will set up for you

4. Once they’ve received the money from your customer the remaining amount (e.g. 20%) will appear as available funds on your on-line account

5. You’ll have to pay them a discount charge (interest) and fees – the amount depends on which invoice financier you use. This will be deducted directly from your available funds

6. Finally you or your accountant will need to reconcile the balance on your online account, back to your own sales ledger. In theory, the debtors balance on your on-line account should always match the debtors balance on your accounting system. Your provider will want you to make sure this is the case by completing a reconciliation, usually once every month. Your provider will always make it easy for you to pull a transaction listing from your on-line account is very simple to check against your accounting system. It is also a useful check for you, as it gives the opportunity to correct any errors and to give assurance that you have received the correct funds.

Accounting entries

1. When the invoices are first uploaded onto your on-line account, no accounting entry needs to be made, as at this point there has been no change to assets or liabilities

2. The 1st time you will make an accounting entry is when funds are withdrawn from you facility. You will have effectively taken a short term loan, so the double entry will be-

DR Bank
CR short term loan (Current liability)

It should be noted that this is not a reduction a debtors, but a short term loan only secured against debtors, so your debtors balance will remain unchanged

3. When your customer pays the full amount, your debtors will reduce as normal, but your bank account will be unaffected as the cash will be paid directly into your facility. Therefor this will be a reduction of the short term loan you have posted. The double entry will be-

DR short term loan (Current liability)
CR Debtors

The simplest way to post this is to set up an extra nominal code for the facility, as another bank account on your accounting system. This way you can post any receipts from debtors as normal, only using the new code as your bank nominal, effectively posting the entry above

4. Interest & charges should be posted as an expense in your P&L, with the other side of the entry being an increase in the amount you owe. The double entry will be-

DR Expenses-P&L
CR short term loan (Current liability)

5. The result of all these entries will leave you with a liability on your balance sheet which reflects what you owe the invoice finance provider at a point in time. This should match the balance on your client statement

Drawdowns + fees – customer receipts= client statement balance

6. This should also be reconciled at the end of each month separately from your debtors reconciliation. It can be easy to confuse the two, but the debtors reconciliation is to match the debtors balance to your accounting system, whereas the client statement reconciliation is to match what you owe the provider to your accounting system

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