Trade finance and invoice finance: how they work together

For a UK importer, distributor or manufacturer, the hardest part of a growing order book is rarely winning the work. It is the gap between paying your supplier and being paid by your customer. You often have to settle the factory or the freight before the goods even land, then wait 30, 60 or 90 days after delivery for the sale to convert into cash. Two facilities exist to bridge that gap, and they are at their most powerful when they are used together.

Trade finance funds the first half of the cycle, getting the goods bought and delivered. Invoice finance funds the second half, turning the completed sale into working capital. When they are structured to dovetail, the invoice finance advance repays the trade facility, and you cover the entire journey from paying the supplier to being paid by the end customer without tying up your own cash.

What trade finance actually does

Trade finance is the funding that gets stock onto your shelves or into your production line before you have the money to pay for it. In practice it takes a few forms, and lenders will often combine them on one facility:

• A purchase order facility, where the lender advances against confirmed orders from your customers so you can pay your own supplier.
• An import or trade loan, a short term advance that settles the supplier invoice directly, frequently in the supplier's own currency.
• A letter of credit, where a bank guarantees payment to the overseas supplier once agreed shipping documents are presented, which reassures a supplier who does not yet know you.

The common thread is that the money leaves to pay a supplier, and the facility is repaid once you have sold the goods on. Trade finance is deliberately short term and transactional. It is tied to a specific deal, not a rolling overdraft.

What invoice finance actually does

Invoice finance releases cash that is locked up in your unpaid sales invoices. Once you have delivered the goods and raised a valid invoice, the lender advances a percentage of its value straight away, typically 80 to 90 per cent, and pays you the balance once your customer settles, less their fee. It comes as factoring, where the lender manages collections, or as confidential invoice discounting, where you keep control of your ledger and your customer need not know a lender is involved.

Invoice finance is a revolving facility. As you raise new invoices, more funding becomes available, and as customers pay, headroom is restored. That rolling nature is exactly what makes it the natural repayment route for a trade facility.

How the two facilities dovetail

The join is the whole point. Read in sequence, a combined structure looks like this:

1. You receive a confirmed order from a creditworthy customer.
2. The trade facility pays your supplier so the goods can be manufactured, shipped and delivered.
3. You deliver to your customer and raise the sales invoice.
4. The invoice finance facility advances against that invoice, and the advance is used to clear the trade facility.
5. Your customer pays the invoice in full, the invoice finance drawing is settled, and the remaining balance lands with you.

This is often called the take out. The invoice finance advance takes out the trade line at the exact moment the risk changes from goods to be delivered into a confirmed receivable. Lenders like it because each facility is repaid from a clean, predictable source, and you like it because the two are timed to hand over to each other rather than leaving a funding gap in the middle.

Trade finance gets the goods in the door and invoice finance gets your cash back out. Used together they fund the entire cash cycle, not just one end of it.

A worked example

Take an importer with a confirmed order. The numbers show how the two facilities pass the baton:

• The importer buys £200,000 of stock from an overseas supplier, funded by a trade finance facility that pays the supplier directly.
• The goods are shipped, cleared and delivered to a UK customer, who is invoiced £280,000 on 60 day terms.
• Invoice finance advances 85 per cent of that invoice, which is £238,000, as soon as the invoice is raised.
• £200,000 of that advance clears the trade facility, plus its fee. The importer keeps the surplus as working capital straight away rather than waiting 60 days.
• Sixty days later the customer pays £280,000. The invoice finance drawing of £238,000 is repaid, and the remaining £42,000 is released to the importer, less the invoice finance fee.

The importer has turned an £80,000 gross margin into a completed deal without ever funding the £200,000 of stock from its own reserves, and without waiting two months to see the cash.

What each lender needs to see

The two facilities assess different risks, so they ask for different things. Understanding this early makes an application far smoother.

For the trade finance

• Confirmed purchase orders from your customers, not forecasts.
• A reliable supplier with a track record of delivering to spec.
• Clear shipping and delivery terms, so the lender can see when the goods become a saleable asset.

For the invoice finance

• Creditworthy end customers, because the advance is only as strong as the debtor behind the invoice.
• Clean, undisputed invoices raised only after the goods are genuinely delivered.
• A well kept sales ledger with a spread of customers rather than reliance on a single account.

Costs to expect

Trade finance is usually priced as an arrangement or utilisation fee plus interest for the days the facility is drawn, so a deal that turns around quickly costs less than one that sits open for months. Where a letter of credit is involved there is a separate issuance charge. Invoice finance carries a service fee, often a fraction of a per cent of turnover, plus a discount charge on the funds you draw. Because the two facilities are short and self liquidating, the cost is best judged against the margin on the specific deal rather than as an annual rate on your whole business. In the worked example above, the combined fees only need to be comfortably below the £80,000 margin for the structure to pay for itself.

Currency and import considerations

Importers rarely buy in sterling. If your supplier invoices in dollars or euros while your customer pays in pounds, the gap between paying out and being paid exposes you to exchange rate movement. Many trade facilities can settle the supplier in their own currency and let you fix the rate with a forward contract, so the sterling cost is known on day one. Factor in duty, VAT and freight as well, since these fall due around import and can be part of what the facility needs to cover before the goods can be sold.

The risks that break the chain

The structure is elegant when it runs to plan, but every link depends on the goods being delivered and the invoice being paid. The main risks are worth naming plainly:

• Delivery failure. If the supplier ships late or the goods do not clear, there is no invoice to raise, and the trade facility has to be repaid from another source.
• Disputes. A short delivery or a quality complaint can make an invoice uncollectable, which removes the take out that was meant to clear the trade line.
• Customer default. If the end debtor fails, the invoice finance advance may be recoursed back to you, so customer credit quality matters as much as your own.

Good structuring reduces these risks with clear delivery terms, sensible credit checks on end customers, and in some cases credit insurance behind the receivable. None of it removes the need to deliver clean goods on time, which remains the foundation the whole structure rests on.

Bringing it together

Trade finance and invoice finance are not competing products. They are two halves of the same working capital cycle, and the businesses that scale an import or distribution operation smoothly are usually the ones that run them in tandem. If you are weighing up an order you could win with the right funding behind it, it is worth talking through how the two facilities would dovetail for your specific deal. As a commercial finance broker that is not regulated by the FCA, which is correct for business to business finance, we work across the specialist invoice finance lenders and can help you shape a structure that fits your suppliers, your customers and your margins. Speak to the invoice finance team and we will talk it through properly.