Invoice Factoring vs. Bank Line of Credit
Last Updated October 4, 2024
For business owners, managing cash flow wisely is a pivotal factor in determining long-term success, particularly for small business owners. Given 60% of small businesses struggle with cash flow, it is not a unique problem to have, and owners often look to third parties to assist with these struggles.
Two of the most common options to help fund a business are invoice factoring and bank lines of credit. Because your best financing option will differ depending on several aspects of your business, it is important to analyze invoice factoring vs. bank lines of credit in-depth, including how these financing options differ and what purposes they each serve.
What Is Invoice Factoring?
Invoice factoring is the process of selling outstanding invoices to a third-party company (factoring company).
First, a factoring company such as altLINE will fund a cash advance of 80-90% of the outstanding invoice. This makes for a great way to keep your cash flow consistent, as it removes the process of waiting for your customer to pay an invoice to receive working capital.
The responsibility is then on your customer and the factoring company to exchange and collect payment. Once paid, you receive the remaining 10-20% of the invoice, minus a “factoring fee” (typically 1-5%) charged by the factoring company.
Cash flow uncertainty and slow paying customers are often to blame when business owners are dealing with cash flow problems. Invoice factoring helps tackle both of these challenges at once.
If you would like a better idea of what to expect when working with a factor, an invoice factoring calculator can help you estimate your cash advances, factoring fees, and cash due to you at the end of the factoring process.
It should be noted there are a couple of different factoring options if you’ve determined invoice factoring is the right fit for your business.
Invoice Factoring with an Independent Company
If your business has been turned down by a bank for a line of credit or a loan, you can choose to work with an independent factoring company instead. While a good independent factoring company can still help accelerate your cash flow, there is noticeable risk involved. Independent factoring companies are not affiliated with a bank, so they usually borrow money from a third-party to fund your invoices, meaning rates typically aren’t as competitive as a bank factor can offer.
Invoice Factoring with a Bank
A bank factor like altLINE provides the same service as an independent factor but offers more advantages, including enhanced transparency, financial stability, and more competitive rates due to providing a direct source of funds.
Even business owners who have been rejected for a commercial loan by one bank can still factor with another bank that offers invoice factoring. If you hope to ultimately land a commercial loan, experience working with a factoring company may make for an easier transition.
What Is a Bank Line of Credit?
A bank line of credit is a flexible loan from a bank or financial institution. While invoice factoring strictly involves selling outstanding invoices to a third-party company, bank credit lines can be used to fund different tasks or projects and requires more responsibility on the end of the business owner. Not meant to be used for one-time purchases or transactions, a bank line of credit is rather a defined dollar amount that a small business owner can use as needed – similar to a credit card.
A bank line of credit involves fluctuating interest rates and fees, determined by uncontrollable economic factors. Each month, you are required to pay the balance you borrowed, plus interest.
According to the FDIC’s 2024 Small Business Lending Survey, lines of credit are one of the most common sources of funding offered by banks for small businesses in particular (88% of small banks and 86% of large banks offer it as a product). However, that doesn’t mean it’s necessarily a better option than factoring, which is also tailored for small business owners. It simply comes down to the borrower and their respective needs.
Bank Loan vs. Line of Credit
There is a difference between a line of credit and a traditional loan. While a bank loan is based on the borrower’s need and requires fixed payments, a line of credit acts like a reusable loan, offering more flexibility.
To qualify for a line of credit, you will likely need a strong credit score. Banks typically have more leeway when offering loans, though even these can be difficult to get for startups and those with poor credit histories.
Related: Invoice Factoring vs. Bank Loans
Invoice Factoring vs. Bank Line of Credit
| Invoice Factoring | Bank Line of Credit | |
| Helps with Various Project Startup Expenses | ❌ | ✔️ |
| Helps Accelerate AR Cash Flow | ✔️ | ✔️ |
| Has Predefined Rates/Fees | ✔️ | ❌ |
| Approval is Dependent on Your Credit | ❌ | ✔️ |
| Approval is Dependent on Your Customers’ Credit | ✔️ | ❌ |
| Financing Method Aimed to Help Grow Your Business | ✔️ | ✔️ |
Invoice Factoring:
Accelerates Cash Flow
The main reason business owners – especially new or small business owners – work with proven factoring companies like altLINE is because it eases and accelerates accounts receivable cash flow. A report by Quickbooks estimated that the average small business has $84,000 in outstanding customer invoices at any given time.
Rather than waiting 30 to 90 days to receive cash from your customer, you can sell your outstanding invoices and receive working capital in a matter of days. The 80-90% cash advance provided by the factoring company also safeguards your cash flow.
Offers a More Lenient Approval Process
Factoring companies are notably indiscriminate when it comes to selecting small businesses to work with, as the financial history of the debtor (your customer) is equally, or more, important to them than aspects of your own financial history. Therefore, having a fair to low credit score or owning a brand-new business won’t necessarily deter a factoring company from working with you.
Alleviates Time-Wasting Accounts Receivables Responsibilities
Business owners may be wary of trusting a third-party company to handle aspects of their accounts receivables processes. After all, your business is your “baby”, and allowing a factoring company to take control of your invoices involves a lot of trust.
However, according to Chaser, 87% of businesses reported that their average invoice was paid late in 2022. Mid-sized businesses reported that, on average, 14 hours per week were spent following up and chasing late invoice payments.
A factoring company relieves this pressure and provides you more time to focus on growing your business and less time worrying about late invoice payments.
Bank Line of Credit:
Provides Spending Flexibility
A line of credit is used by business owners because the money can be spent for a variety of tasks, rather than to solely fund things like unpaid invoices.
This does require a responsible business owner who will pay back the balance borrowed in a timely manner to avoid extra fees, especially since they’re allowed to pull funds on an ongoing basis.
Demands a Stricter Approval Process
Getting approved for a line of credit requires a high credit score, while invoice factoring companies are typically more forgiving of low credit scores. New or small business owners tend to have an easier time qualifying for invoice factoring vs. a bank line of credit.
Trying, failing, and then learning from your mistakes before succeeding is a natural entrepreneurial process. Nearly half of small businesses fail within five years, and 65.7% fail within 10 years. Because many successful business owners are not on their first business, leading to less-than-ideal credit scores, a bank line of credit is not always an option.
Includes Varying and Unpredictable Interest Rates
A line of credit from a bank does not include a fully predefined rate of service, meaning you must be prepared for some unexpected fluctuations. This lack of stability could make it hard to predict what the money you borrow will actually end up costing you.
You should also be prepared for higher interest rates than other credit facilities because lines of credit are not intended for one-time purchases, which increases risk.
Choosing Between Invoice Factoring vs. Bank Line of Credit
Business owners weighing invoice factoring vs. bank lines of credit might find that both lending options could help finance a project by boosting capital. Not every business has the same needs, though, so consider the following:
You should consider using a factoring company if…
- You run a new or small to medium-sized business
- You have slow-paying customers with outstanding invoices
- You need help with the AR collections process
- You’re struggling with cash flow
- You need to increase your working capital
- You have little or poor credit history
You should consider a bank line of credit if…
- You run an established, large business
- You have a history of high credit
- You’re looking to borrow capital for flexible spending purposes
- You’re not deterred by unpredictable interest rates
When To Use Invoice Factoring vs. Bank Line of Credit
Consider the following hypothetical illustrations of businesses searching for financing:
1. Staffing365 is a small staffing agency whose owner has subpar credit due to a past business going bankrupt. One of Staffing365’s clients, who accounts for a large chunk of their accounts receivable ledger, has failed to meet invoice payment terms on more than one occasion. Thus, Staffing365 missed payroll, leading to serious employee morale issues.
Staffing365 turns to invoice factoring to solve their customer payment problems. Therefore, even if their customer submits late payment going forward, they won’t feel the effects thanks to the cash advance they received from their factor.
2. Tech Solved has been in business for more than five years. They are in the IT solutions realm and help their customers solve serious IT-related issues that could compromise security or finances. Tech Solved has a monthly ledger surpassing $7,000,000.
Tech Solved needs funding to purchase new, expensive security software that is necessary to keep up with industry standards. The exact cost for purchase and implementation is unknown. They have never had issues with customers failing to pay on-time, but rather they need capital for flexible spending. Therefore, Tech Solved secures a bank line of credit to fund this new equipment.
Ready To Start Using a Factoring Company?
Now that you know the difference between invoice factoring vs. a bank line of credit and you’ve calculated your invoice factoring costs, fill out our free quote form or give us a call today at +1 (205) 607-0811 to begin factoring. Our representatives will happily discuss how altLINE can help improve your cash flow.
Michael McCareins is the Content Marketing Associate at altLINE, where he is dedicated to creating and managing optimal content for readers. Following a brief career in media relations, Michael has discovered a passion for content marketing through developing unique, informative content to help audiences better understand ideas and topics such as invoice factoring and A/R financing.
