Last Updated on February 9, 2023
When it comes to non-traditional financing solutions, invoice financing and factoring are common alternatives to transforming your accounts receivables for quick funding.
Both options are similar as they provide a cash advance for business owners to increase working capital and scale their growth. However, some differences exist between them, and in this article, you’ll explore these differences and how to choose the best option for your business.
What Is Invoice Factoring?
Invoice factoring is a type of financing where businesses sell their receivables to a factoring company for a cash advance in exchange for a small factoring fee. It is a straightforward process which is outlined below:
- Invoice your client
- Sell the unpaid invoice to a factoring company
- Receive a percentage of the invoice value as a cash advance (typically between 80% and 90% of the invoice face value)
- Your client pays the invoice
- You receive the remaining invoice value minus factoring charges (typically between 1% and 5% of the invoice face value)
To get approved to work with a factoring company, the factor typically considers the financial worth of your invoices, the reliability of your customers, and the sector of your business. Because your approval is largely tied to your customers’ reliability and creditworthiness, rather than your own business’ credit history, invoice factoring can be a great option for business owners with poor credit.
Example of Invoice Factoring
Below is an example of the invoice factoring process in action:
A business owner sells a $10k invoice, and the factoring company provides an advance rate of 80% for a 3% factoring fee. The seller would receive an advance of $8,000 (80% of $10,000). When the customer pays the invoice in full after 1 month, the factoring company would pay the business owner the remaining invoice value ($2,000), minus the 3% factoring fee ($300), resulting in the business owner receiving $1,700 once the customer has paid.
What Is Invoice Financing?
Invoice financing is also known as invoice discounting and is another common type of alternative financing. With invoice financing, a business owner receives a loan from the financing company that is secured against the business’ invoices. This loan is typically 70% to 90% of the invoice value. Once the business’ customers pay their invoices, the remaining value of the invoices is paid to the business, minus a small financing fee (typically between 1.5% and 2.5%).
With this type of financing, the lender is not responsible for obtaining payments from the business owner’s clients. Instead the business’ clients are unaware that the business is working with an invoice financing company. This process is often called confidential invoice discounting because the customers do not work with the financing company at all. This differs from invoice factoring because the factoring company works directly with your customers.
Example of Invoice Financing
A business owner takes a loan against a $10k invoice, and the lender offers an advance rate of 90%. The business owner receives an advance of $9,000 (90% of $10,000). When the customer pays the invoice in full, the lender deducts an agreed lending fee of 1.5%, and the remaining invoice value is paid to the business owner ($1,000) minus $150 (1.5% of $10,000), resulting in the business owner receiving $850 ($1,000 minus $150).
Differences Between Invoice Factoring and Invoice Financing
Below is a summary of the key differences between invoice factoring and invoice financing.
|How Does It Work?
|Sale of invoices for a cash advance
|Use of invoices as collateral for a loan
|Factoring company collects payments from debtors
|Client collects payments from debtors
|Confidentiality is maintained
|Also Known As
Should I Use Invoice Factoring or Invoice Financing?
The decision to use invoice factoring or invoice financing depends on the needs/size of your business, the cost, and your customer relationships. Among others, scalable financing and quick growth trajectory are why companies use invoice factoring and invoice financing. However, careful consideration of the following factors will guide you to make the best choice for your business when it comes to financing alternatives:
- Customer-Client relationship: Depending on your industry and niche, your clients can either be wary of your alternative financing options or they might not mind. If the majority of your client base is skeptical of your cash flow problems, it might be a better option to use invoice financing instead of factoring to minimize the impact on your clientele base. If you do not think your customers will mind that you are using an alternative financing method, then factoring may be the better option.
- Cost: Since factoring is generally a bit more expensive than invoice financing, you might need to consider the impact of the fees you have to pay for these services. For instance, if you run a small business, especially in competitive industries, you are at a higher risk of running into loss due to a low-profit margin as your business may not be able to bear the prolonged loss. If you are concerned about the cost, invoice financing may be a better option since the fees tend to be a bit lower.
- Flexibility: If you want to choose which invoices to use for financing purposes, factoring may be the option for you. You tend to have more flexibility in which invoices you factor, while with invoice financing, you often have to submit your entire invoice book for financing.
- Resourcing: If you have a smaller business and limited resources, invoice factoring may be preferable. With invoice factoring, the factoring company is responsible for collecting payments from your customers, which gives you one less responsibility to worry about. If your business is large enough that you have someone who can handle the collections process, then invoice financing may be preferable to save money with lower fees.
How altLINE Can Help
To learn how you can use accounts receivable financing, fill out this form and an altLINE representative will reach out to you to discuss your options to help you finance your business and collect your unpaid invoices.
Deborah Sabinus is a content marketing writer who works across B2B SaaS and Finance industries. She specializes in bridging the gap between businesses and their audience through content. She is committed to helping readers understand complex topics and help them make informed decisions with content.