Managing your business’s cash flow is crucial to long-term business success. You need customers to pay their invoices on time to ensure your business has funds for projects, inventory management, and other short-term expenses. Many companies use invoice factoring and financing when they need to improve their cash flow.
Invoice factoring and financing both involve providing companies with immediate funds while they wait for customers to pay their invoices. While these methods are similar, there are a few significant differences. Comparing invoice financing vs. factoring helps your company understand which invoice payment strategy could benefit it the most.
Invoice factoring is when a company sells outstanding accounts receivables at a discount to a third-party factoring company. The factoring company will receive the customer’s invoice payment.
Before the customer pays, the factoring company pays the business a portion of the outstanding invoice upfront to help with its short-term liquidity needs. Once the factoring company receives the customer’s full payment, it sends the remaining invoice amount to the business minus its fees.
Here is an overview of the invoice factoring process:
An example of invoice factoring can clarify the nature of the transaction. Suppose your business sends a $50,000 invoice to a customer with 60-day repayment terms but needs the funds before the 60 days are up. You might contact a factoring company to set up a factoring agreement.
The factoring company might pay you $45,000 upfront, which is 90% of the total invoice value. The customer pays the factoring company $50,000 after six weeks, and your business receives $3,000, the remaining balance minus $2,000 in fees.
Also called invoice discounting, invoice financing is the process by which a business borrows money against its outstanding invoices. A lender or discounting company pays the company a percentage of its unpaid invoices as a line of credit or loan. The customer then pays your business the invoice amount, and you repay the lender for the loan, plus any interest and fees.
The invoice financing process follows these steps:
In the example of the $50,000 invoice above, invoice financing might produce a different result. If your business needs the $50,000 before the 60 days are over, it might contact a lender or discounting company to finance the invoices.
The lender might provide 90% of the invoice value upfront, paying your business $45,000. However, the lender might charge a fee of 3% for each month the customer leaves the invoice outstanding. If the customer pays you the full invoice amount by day 50, your business keeps $2,000 and pays the lender $48,000, the original $45,000 plus $3,000 in fees.
When comparing invoice financing vs. invoice factoring, several key differences could impact a business’s choice. The two significant differences between invoice factoring and financing are:
In invoice factoring, the customer sends their invoice payment to the third-party factoring company rather than to the business from which they purchased the goods or services. The third-party factoring company becomes responsible for pursuing customer payment. Once the factoring company buys the outstanding invoices, the customer no longer interacts with the business.
The opposite is true in invoice financing — the customer pays the full invoice amount back to the business, which retains its responsibility for pursuing customer payment. The customer never interacts with the third-party lender, completing the transaction through the company.
One of the most significant differences when comparing receivables financing vs. factoring is the financing structure of each strategy.
With accounts receivables factoring, businesses sell their unpaid accounts receivables to a factoring company and receive an advance upfront. The factoring company pays the remaining balance when the customer completes their payment.
In invoice financing, businesses receive an upfront cash payment as a loan or line of credit backed by their unpaid invoices. Upon the customer’s payment of the invoice amount, the business must repay the lender for its loan.
Deciding if invoice factoring or financing is better for your business requires careful consideration. A significant factor influencing your business’s decision is whether it wants more control over its accounts receivables or is comfortable having less control.
Invoice factoring hands over the ownership of your invoices to the factoring company and transfers the responsibility to pursue customer payments to them. For some companies, invoice factoring could be a relief, allowing them to focus more resources on core business tasks.
Other businesses may not want to hand over their unpaid invoices to the factoring company. Selecting a factoring company with extensive experience in your business’s industry can provide peace of mind that experts are handling your accounts receivables.
However, invoice financing could be a better option if your business isn’t comfortable transferring its accounts receivables to a third party. Invoice financing may also be ideal if your company has the resources to pursue outstanding invoices and typically receives on-time payments.
Another factor that could impact your choice is whether the strategy relies on your company’s or your customer’s credit score. Factoring companies are interested in your customers’ credit since they buy ownership of the accounts receivables. Invoice factoring could appeal to new businesses or those with bad credit scores.
When comparing accounts receivable financing vs. factoring, it’s essential to analyze the pricing options and agreement terms. Many factoring companies expect to take over most of your company’s invoices rather than a small batch of accounts receivables.
Often, these companies expect your business to enter a factoring agreement for a significant period, sometimes up to a year. In contrast, invoice factoring usually provides a short-term solution until a batch of invoices is paid. Invoice factoring could therefore be an ideal solution for businesses that need a long-term financing source.
While invoice financing and invoice factoring both provide a solution for a business’s short-term liquidity needs, one option may be better than the other in certain situations.
Invoice factoring may be the best option for companies looking to reduce the resources they spend pursuing customer payment or need a long-term solution to their liquidity needs. This strategy provides your company with several benefits, including improved cash flow, increased operational efficiency and independence from traditional debt.
At FactorFox, we offer expert factoring services and an all-in-one funding solution. We have years of experience factoring invoices for businesses ranging from construction to medical companies. Our clients benefit from highly flexible pricing, fast turnaround, a dedicated support team and a growing list of additional features to support their cash flow needs.
Contact us to learn more about pay-as-you-go invoice factoring with FactorFox.