Invoice factoring and bad debt insurance

Why freelancers look at invoice finance

Late payment is the number one cashflow problem for UK freelancers. When a client owes you money and you have bills to pay, waiting 60 or 90 days for payment can feel impossible. Invoice finance and bad debt insurance are two categories of financial product designed to solve this problem.

There are three main options:

• Invoice factoring: sell your invoices to a third party and get paid immediately.
• Invoice discounting: borrow money against your unpaid invoices.
• Bad debt insurance: insure yourself against clients not paying at all.

Each one works differently, costs differently, and suits different situations. For most freelancers, none of them are necessary if you have a solid chasing process in place. But it is worth understanding what they are so you can make an informed decision.

Invoice factoring explained

Invoice factoring means selling your unpaid invoices to a factoring company (called a “factor”). The factor pays you a percentage of the invoice value upfront, usually 70% to 90%, and then collects the full amount from your client. When the client pays, the factor releases the remaining balance to you minus their fee.

How the process works:

1. You raise an invoice to your client as normal.
2. You send a copy of the invoice to the factoring company.
3. The factor pays you 70% to 90% of the invoice value within 24 to 48 hours.
4. The factor contacts your client and collects payment directly.
5. Once the client pays, the factor releases the remaining balance minus their fee.

There are two types of factoring:

• Recourse factoring: if your client does not pay, you have to buy the invoice back. This is cheaper but carries more risk for you.
• Non-recourse factoring: the factor absorbs the loss if your client does not pay. This costs significantly more.

The key thing to understand is that with factoring, the factor takes over the collection process. Your clients will know you are using a factoring company because the factor contacts them directly.

Invoice discounting explained

Invoice discounting works differently. Instead of selling your invoices, you borrow money against them. The lender advances you a percentage of your outstanding invoices (again, typically 70% to 90%), and you repay the advance when your clients pay you.

The important difference is that you still manage the relationship with your client. Your client pays you directly and they do not need to know you are using invoice discounting. This is sometimes called “confidential invoice discounting”.

Invoice discounting tends to be available only to larger businesses because the lender needs confidence that you have a robust credit control process. Most providers require a minimum annual turnover of £100,000 or more.

Bad debt insurance explained

Bad debt insurance (also called trade credit insurance) protects you if a client does not pay at all. You pay an annual premium, and if a client defaults, the insurer pays out a percentage of the invoice value, typically 80% to 95%.

This is different from factoring and discounting because it does not improve your cashflow day to day. It is purely a safety net against non-payment. You still invoice your clients normally and wait for them to pay. The insurance only kicks in if they fail to pay entirely.

Major providers in the UK include Atradius, Euler Hermes (Allianz Trade), and Coface. There are also newer providers like Nimbla that offer policies aimed at smaller businesses.

Costs compared

Here is a rough comparison of what each option costs for a typical freelancer:

For a freelancer billing £3,000 per month, a 3% factoring fee on each invoice means giving away £90 per month, or £1,080 per year. That is a significant chunk of income.

Pros and cons at a glance

Do most freelancers need invoice finance?

In most cases, no. Here is why:

• The amounts are too small. Invoice factoring is designed for businesses with large volumes of invoices. If you send 3 to 5 invoices per month, the fees and minimum charges make it uneconomical.
• Most late payers do pay eventually. The vast majority of late invoices are paid within 60 to 90 days. True bad debts (clients who never pay) are relatively rare if you vet clients properly.
• A good chasing process is usually enough. Automated reminders, a firm follow-up process, and the threat of statutory interest resolve most late payments without needing to sell your invoices.

Invoice finance makes more sense if you are a growing business with £100,000+ turnover, large invoices with long payment terms (60 to 90 days), and the need for consistent cashflow to fund staff or stock.

Better alternatives for most freelancers

Before looking at invoice finance, make sure you have these basics covered:

1. Set clear payment terms upfront. 14 or 30 days, stated on every invoice. See the payment terms guide.
2. Automate your reminders. PennyFetch sends reminders before and after the due date so you do not have to chase manually.
3. Charge statutory interest. You have the legal right to charge 11.75% per year on overdue invoices. Use the late payment calculator to work out the figure.
4. Send a Letter Before Action. A formal demand letter resolves most stubborn debts. See the LBA guide.
5. Vet new clients before starting work. A quick check on Companies House can tell you a lot. See the client vetting guide.
6. Ask for deposits on new projects. Getting 30% to 50% upfront significantly reduces your risk.

These steps cost nothing (or close to nothing) and will resolve the vast majority of late payment problems without giving away a percentage of your income to a factoring company.