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