There’s a lot of confusion among small business owners who are new to accounts receivable finance about the differences between invoice factoring and invoice financing. It is important to note that these terms are not interchangeable. Choosing the right invoice financing or factoring service based on your business needs and current situation requires knowledge of the differences between them. Read on to find out what makes invoice financing and factoring different and how they can help you get the money you need.

What is Invoice Factoring?

Invoice factoring is sometimes called debt-factoring or factoring. The invoice factoring process involves selling your outstanding invoices to a third-party commercial finance company for a short period. In factoring, the company offering the loan is called the factoring company. A factoring company buys your outstanding invoices (your accounts receivable) from your business and then pays you 85% to 95% of the total invoice amount. 

Besides this, factoring companies also collect payments from your customers after you sell your invoices to them. Factoring companies pay you the remaining balance once your customers have paid their invoices. In general, factoring companies charge between 1% and 6% per month, but the terms may vary depending on your particular business and the factoring company. Depending on the factoring company, you will be charged monthly, weekly, or even daily fees based on the time your invoices take to get paid. If your invoices aren’t paid on time, the higher the factor fees are likely to be.

What Is Invoice Financing?

Similar to invoice factoring, invoice financing lets you lend money against past due invoices in a short-term manner. Typically, it helps companies improve their cash flow and working capital. With invoice financing, you continue to manage your sales ledger, chase payments, and process invoices yourself. With invoice financing, you can use your invoices as financial proof that you will be able to repay the lender on a loan if you offer extended credit terms to your customers – between 30 and 90 days. 

In invoice financing, a past-due invoice is used as collateral to secure your loan or line of credit. Based on the value of your invoices, your credit limit is determined. Typically, invoice financing enables lenders to give you up to 85% of your invoice upfront. When your borrower pays your invoice, you pay the lender back. That is advantageous since it prevents you from having to wait for your money, which is essential if you are in need of working capital quickly.

It’s also worth noting that invoice financing may also be referred to as invoice discounting at times.

Differences Between Invoice Factoring Vs Invoice Financing

Both invoice financing and invoice factoring share a few similar characteristics, such as the use of unpaid invoices as collateral. However, it is important to understand the fundamental differences between the two options.

Control and visibility 

• In invoice factoring, the factoring company collects invoice payments directly from customers by selling your unpaid invoices to them. In addition, they can take an active role in credit checking and chasing customers’ payments for you, so you no longer have to worry about this burden if your credit control has been particularly poor.  
• By using invoice finance, you retain control of your own sales ledger and collection of payments. Using invoice finance is always confidential, so your customers will remain unaware of any agreement you have with them.

Funding and advances adjustments

• Factoring allows you to receive advance funding for individual invoices. Adjustments are made daily according to your funds.
• With invoice finance, your sales ledger is not managed by an invoice discounter. In most cases, you will need to show any monthly changes in the disallowed debt. Your finance provider can then adjust the funds you have available. Financing your invoices can result in larger adjustments than small daily adjustments however you may have a harder time dealing with them.

Terms of payment for invoices

• You have less flexibility with factoring since invoice amounts are generally advanced in the order that they are received.
• Financing invoices give you a little bit more flexibility and let you select exactly when you want to finance them.

Cost

• With invoice factoring, you usually get lower fees for the amount of invoices factored and the length of the agreement; you could be paying up to 15% of the invoice amount for a single sale.
• Invoice financing typically costs between 3% and 5% per month, depending on the number of your invoices.

Risks of Invoice Factoring Vs Invoice Financing 

• Since factoring companies generally manage collections and credit control, factoring is less risky for the lender. There is virtually no chance of non-payment which makes it easier to secure for businesses with financial challenges or a lack of or poor credit history. 
• Due to the lack of direct contact with your debtors, invoice financing is riskier for lenders. It is not under their control. To reduce the risk of lending, invoice finance companies typically lend only to businesses with a positive net worth and earnings of at least a million dollars per year. Some invoice finance companies may use a higher turnover of debtors and better quality of the debtor book as a risk-mitigation strategy. Generally, businesses receive better rates and advances when they have increased security, which means fewer contractual obligations, personal guarantees, and debenture obligations.

Advantages and Disadvantages of Invoice Factoring Vs Invoice Financing 

You will see a quick increase in your cash flow from both. Each has its own advantages and disadvantages due to their differences, however.

Invoice Factoring Pros

• Your finance company will normally handle your sales ledger, manage your credit management and chase payments, allowing you to focus on running your business instead. Some will only operate on this basis but others, like Sallyport, will offer a confidential service too;
• When you have a good credit check process in place, you are more likely to deal with customers who pay on time, mitigating risk for the company. Factoring companies will limit bad debt for the organization;
• Your suppliers may be able to negotiate better terms with you when you work with a factoring company.

Invoice Factoring Cons

• There is a possibility that your customers would rather deal directly with you;
• Some business owners are concerned that the perception of the business may be negatively impacted by the presence of a factor, especially if they’ve had previous dealings with a factoring company whose service was under-par. In actual fact, this concern becomes an advantage when working with a professional factor in that the additional stability and cash flow that comes with factoring can actually help to build the business’ credibility and credit score, ultimately allowing them to attract more customers;
• Factoring companies do charge for certain additional services and these fees are usually dependent on the credit score of your customers and their ability to pay. 

Invoice Financing Pros

• The financing process can be confidential, which means your customers won’t know you are borrowing against them;
• Keeping control over customer accounts and managing debt collection helps you strengthen your relationship with them;
• The cost of invoice financing is typically a little lower than the cost of factoring;
• With more modern providers, the director may be at less risk.

Invoice Financing Cons

• To be accepted by an invoice financing borrower, you’ll need to have a strong and established credit collection process;
• Only businesses with a positive net worth and a turnover of $100,000 tend to work with invoice finance companies;
• Invoice financing becomes a major source of cash for some businesses and leaving it can negatively affect their operations and sales. That being said, the goal for a good factoring company will be to support their client in building the business to a point where they can apply for traditional finance again.

How Invoice Financing or Invoice Factoring Could Accelerate Your Business’ Growth

Both invoice financing and invoice factoring can provide you with funding quickly, which is one of their greatest advantages. When you have spotted an opportunity for business growth, but you need to invest in operations and new staff immediately – and your money is tied to receivables – invoice factoring could allow you to get the money you need now while also outsourcing credit control, allowing you to focus on the new opportunity without distraction.

Furthermore, invoice financing or factoring can be a great option for businesses that aren’t eligible for traditional business term loans from banks or SBA loans. Business loans typically require a certain length of time in business and a certain amount of revenue, as well as the owner’s personal credit score and the company’s credit profile, if it has one. The traditional route may not be the best option if your business generates substantial invoices, so invoice financing and factoring could be great alternatives.

Invoice Factoring Vs Invoice Financing: Which Is Right for You?

Whatever invoice finance option you choose, the underlying goal is the same – to receive the money owed to you as soon as possible. The result is an improvement in cash flow, which is a key element of business health. Would invoice financing or factoring be a better option for financing accounts receivables? Depending on the particular needs of your business, it may vary. Managing your sales ledgers effectively and your organization’s size are also important factors. The invoice financing model is most common among large, well-funded businesses. However, as the model advances, this is changing. If you have strong relationships with your key customers and can usually collect on their invoices quickly, invoice financing could be a fast and affordable financing solution.

However, small-to-medium sized businesses that have had issues collecting payments and controlling credit in the past may benefit from factoring. Because of its increased credit control, factoring is generally a better option for smaller businesses or new businesses that have exhausted traditional credit lines. 

There are risks associated with borrowing in any form. And lenders take on more risk than borrowers, but it’s still important to understand how your business will be affected before making a commitment. It’s important to note that as with any form of finance, you won’t be protected from non-payment by your debtors and it may be prudent to consider trade credit insurance as a measure against this. So, whenever in doubt, consult your accountant or financial advisor and reach out to the Sallyport team with any further questions you might have on the different types of alternative finance available to you.