How Invoice Finance and Asset-Based Lending Structures Work

Invoice discounting versus factoring

Both invoice discounting and factoring provide an advance against outstanding trade debts, but they differ in who manages the debtor relationship. Under invoice discounting, the company retains control of its sales ledger and collects payment from customers in the normal way; the arrangement is typically confidential and customers are unaware that the invoices have been assigned to the funder. Under factoring, the finance provider takes over the sales ledger management and collects debts directly from customers, making the arrangement disclosed by default.

Invoice discounting is available to companies with an established credit control function and a minimum annual turnover that varies by provider, typically £500,000 upwards. Factoring is more accessible to smaller businesses and those that lack the internal resource to manage debtor collections effectively.

The availability formula

The amount a company can draw at any moment is governed by an availability formula set by the lender. The formula applies an advance rate — typically 70–90% — to the value of eligible invoices assigned to the facility. Eligibility rules exclude invoices that are overdue beyond a defined period (often 90 days from invoice date), invoices to connected parties, retentions, credit notes, and invoices subject to a right of set-off or dispute.

Where a single customer accounts for more than a defined percentage of the debtor book — the concentration limit, commonly 25–33% — the excess exposure above that threshold is excluded from the eligible pool. This protects the lender against the risk of a single large customer default collapsing the facility's collateral base.

Asset-based lending: adding stock, plant, and property

Full asset-based lending (ABL) extends the advance formula beyond debtors to include other balance sheet assets. Stock is typically advanced at 40–60% of cost, subject to valuation of saleability and liquidity. Plant, equipment, and property can be incorporated at loan-to-value ratios reflecting their forced-sale value. The aggregate availability is drawn from a single revolving facility, giving the borrower access to working capital across the full asset base.

ABL is particularly suited to businesses with significant inventory or fixed assets but uneven debtor conversion cycles — manufacturers, distributors, and retailers being the most common users. Because the security base is dynamic, ABL lenders require regular asset monitoring, including monthly or quarterly valuations of stock and periodic audits of the debtor book.

Dilution and its effect on facility headroom

Dilution refers to the reduction in the gross value of assigned invoices through credit notes, discounts, rebates, or disputed items. A high dilution ratio reduces the eligible debtor pool and therefore the available headroom. Lenders monitor dilution closely; a material or unexpected rise in dilution can trigger a reduction in the advance rate or a requirement for the borrower to provide additional security. Directors running invoice finance facilities should maintain accurate records of credit note issuance and resolve invoice disputes promptly to protect facility availability.