Invoice Financing vs Invoice Factoring - What’s the Difference?

What is Invoice Financing?

Invoice financing means borrowing money using your outstanding invoices as collateral. You receive an agreed upon amount of money, usually up to 90% of your invoices as a loan, so your business has the necessary cash on hand to pay employees, buy more inventory and keep day-to-day operations running smoothly.

Once you collect the outstanding invoices from your clients, you pay back the lender including additional fees and interest. Keep in mind that you are still responsible for collecting accounts receivables from the client, which makes invoice financing different from invoice factoring, which we will discuss more in detail below.

Pros of Invoice Financing

Immediate Funds: The purpose of invoice financing is to provide your business with cash upfront based on your unpaid invoices, without having to wait for customers to pay their outstanding balances

Reduced Pressure on Your Business: With money upfront your business will experience better cash flow and you’ll be able to smooth out choppy sales periods and continue to grow your business.

Good Credit Isn’t Required: Invoice financing companies often don’t look at your business’ credit and rather take the score of your clients into consideration when determining if you’re qualified for financing.

No Third Party Interaction with Customers: Unlike invoice factoring, where a third party collects the invoice from your client, your company is still in charge of doing so, and you are able to handle that transaction the way you think is best for the relationship. When you use invoice factoring, you have no control over how they handle this transaction with your client, which could result in strained relationships and other problems.

Cons of Invoice Financing

Higher Costs Than Traditional Loans: Invoice financing involves higher costs than traditional loans from a bank. Some invoice financing companies charge very high fees that leave you with only a fraction of the invoice that you’re owed.

Exposes Your Business: Some invoice financing companies contact your client directly, which can expose your company as one that is having cash flow problems.

Time Consuming: Invoice factoring allows you to hand over unpaid invoices to a third party who is also a lender. With invoice financing, your company is still the one that has to collect your clients’ invoices and needs to keep track of them, which can be time consuming. If a client doesn’t pay, you become liable and need to spend more time finding a solution to the problem, while extra fees for not paying back the loan accrue.

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What is Invoice Factoring?

Invoice factoring is basically the sale of an unpaid invoice (accounts receivable) to a third party. These third parties are lenders, factoring companies and are also known as factors. They then take over the collection of the unpaid invoice from the client and you are getting paid an upfront sum of money, which is usually a percentage of the invoice. Once the invoice is paid, you receive the outstanding balance minus a percentage that acts as compensation for the factoring company.

Keep in mind that this type of financing involves a third party getting in contact with your client and handing the payment of outstanding invoices. This can expose your company as the lendee, but many factoring companies try to be as discreet as possible, giving clients the impression that they are someone from within your company.

Pros of Invoice Factoring

Rapid & Ongoing Cash Flow: This form of financing allows you to skip the step of waiting for your client to pay their invoice and improve your cash flow with immediate funds through invoice factoring. You can then use the money to buy inventory, pay employees and pay for other important day-to-day expenses to keep your business running smoothly.

No Collateral Required: The invoice itself acts as collateral, and therefore you don’t need inventory or any other form of collateral to become eligible for invoice factoring. This is a great option for companies that are just starting out and don’t have other means to get funding to grow.

Saving Time: Staying on top of outstanding invoices and the collection process can be time consuming. Outsourcing this task to a third party that will handle the collection of invoices can save you time and the frustration of any possible issues that may arise. What’s more, you’ll have more time to focus on growing your business and other tasks.

Easy Approval: Even if you don’t have any collateral to lend against and your credit history isn’t stellar, your chances are still very high to get approved for invoice factoring. Factoring companies are more concerned with the payment history of your clients than anything else, which increases your chances of receiving this type of financing.

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Cons of Invoice Factoring

Giving Up Control: When you use invoice factoring, you hand over your invoices to a third party. The factoring company will get in touch with your client and you lose all control over how these interactions are handled, which in some cases might damage your relationship with the client. A good lender can always provide references so you can make an informed decision based on how various factoring companies operate.

Factoring Costs: Invoice factoring may be a great solution for businesses that need money fast and do not have the time to wait for outstanding invoices to be paid. However, keep in mind that this form of financing comes with fees, which usually takes form as 1% to 5% of the total invoice amount which can hurt your cash flow. Thus, brands should carefully compare fees before taking the next step.

Your Business Becomes Liable: Factoring companies get paid by the client, but do not act as collecting agencies. If a client cannot pay their invoice, your business becomes liable for the repayment of the borrowed amount. You can either pay the money upfront or trade in another invoice of the same value to make up for the loss.