Many new businesses find themselves in situations where they can’t afford to pay suppliers and ultimately fulfill customer orders. Established companies can find themselves in the same predicament if they have extended too much credit to their customers.
Invoice financing and factoring can help fix these common issues and get your business back on track. But what is the difference between invoice financing and factoring?
In short, invoice financing allows a business to take a loan against their outstanding, asset-based invoices while factoring involves selling your invoices for cash to a third-party buyer. Let’s dive in and compare invoice financing and factoring.
An Invoice Financing Walk-Through
If your business has identified a shortage of cash to cover supplier costs and expenses and is in need of immediate cash to continue meeting customer orders, invoice financing may be right for you. Let’s discuss an example of the steps needed to get started with the invoice financing process:
- Your business submits an application for invoice financing through a financing company. Customers for this business are usually B2B as this is one of the financing company's qualifications.
- Your business has a good credit score, meets the monthly revenue requirements determined by the financing company, and has creditworthy customers.
- Once the financing company determines that your business has met all of the requirements, it will provide your business with 80% of its outstanding invoices in the form of a credit line.
- The credit line can be received as soon as the next day, and your business is now able to pay its suppliers and any additional expenses that are due.
You might be wondering how the financing company is able to quickly set up the financing and handle any risk involved. After all, traditional banks take far longer and are stricter about extending loans.
That is one of the main differences between a traditional loan and invoice financing. Because these invoices are asset-based, they secure the line of credit being extended to the business.
Once all invoices are paid by customers, the remaining 20% is paid to the business, minus fees from the financing company. Fees are usually in the low single digits and are assessed each week.
For example, the above financing company might charge a 3% weekly fee. This does mean a higher APR than a traditional loan. However, it is lower than using other short-term forms of financing, such as credit cards or payday loans.
Invoice Financing vs Factoring
Invoice financing and invoice factoring are closely related but different. The main difference between invoice financing and factoring is that with invoice financing the business is responsible for all payment management with its customers but with factoring, “the factor” is responsible for payment collections from the business's customers.
With invoice factoring, a company called “the factor” will handle collections of the invoices they are financing. This means that the factor will interact with your customers for all payments of the factored invoices instead of you. Depending on the industry, this can be normal practice and customers will be fine with the arrangement, but if this isn't common, you'll need to communicate with your customers about the payment structure changes.
Invoice factoring will also pay out 80% of the financed invoices upfront. The remaining 20% minus fees will be paid once the factor is paid.
Invoice Financing Loan Structure
If you choose to use invoice financing to help increase your business’s cash flow here’s what you need to know:
- Invoice financing uses an asset-based loan to establish a line of credit. That is why to qualify for invoice financing your business needs to sell real products. This turns any related invoices into asset-based invoices, which the financing company can then use as collateral.
- When we say that invoices are being used as collateral, we really mean that accounts receivables are being used as collateral since that is where invoices are held.
- As your business sends out invoices (depending on the arrangement you have with the financing company) it increases its line of credit. Your business is then able to draw on its line of credit and no longer needs to worry about the cash flow issues that might exist without the line of credit.
Invoice Financing or Factoring: Which One Is For You?
If you find your business has problems paying its suppliers, you’re unable to fulfill customer orders, or you’ve been using traditional loans to plug cash flow holes due to delays in receiving customer payments, invoice financing or factoring is a good choice for you.
Choosing between invoice financing vs. factoring comes down to which payment and loan structure can support your business best.
With the speed of setup and less stringent requirements than a traditional loan, invoice financing or factoring might be the right solution to help get operations back on track. For a further breakdown on the differences between financing and factoring, visit our blog “The Difference Between Factoring and Accounts Receivable Financing.”
Looking for an invoice financing or factoring solution to improve your business’ cash flow? What about something better? Apruve can help you set up a trade credit and A/R automation program for your business buyers. Learn more about Apruve or contact Apruve’s specialists to sign up for a demo today!
If your business would like to get paid in full within 24 hours of invoicing, maybe you should look into Apruve.