Invoice Factoring vs Invoice Financing

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Invoice factoring vs invoice financing. What’s the difference and why do these lending options exist in the first place? But, first, does this story sound familiar?

At your business, orders are coming in at a consistent pace and you expect payment on a large invoice from one of your most reliable customers in a week or two. Your customer is a little bit late paying you, but you can trust them. The problem is, you have to pay your employees in a few days and you’re a little low on cash.

Thanks to technology and innovators, like PayPie, who’ve realized the inherent need for better short-term lending options for small businesses, your outstanding invoices are assets that can be used to get the funding you so desperately need.

24% of SMEs now turn to alternative small business financing, like invoice factoring and invoice financing

Read More: Why You Should Separate Business and Personal Finances. 

It’s hard for SMEs to find short-term business financing

According to the 2017 Small Business Credit Survey, some of the most common financial challenges many small businesses face are funding short-term operational costs, like wages, buying the materials needed to fill a large purchase order or just paying the bills.

The problem: Traditional brick-and-mortar banks aren’t really set up to handle this kind of short-term lending designed to solve a cash flow crunch. Bank are averse to risk and lower collateral levels, requiring more than the promise of a paid invoice. The approval process slower and less certain, which is also why less than half of all SMEs seek business financing from either large or small banks.

The solution: 24% of SMEs now turn to alternative small business financing, like invoice factoring and invoice financing, from online lenders who offer these options. For many of these businesses, these options are the answer to their cash flow crisis.

Invoice factoring vs invoice financing? They are both good options when you’re in a pinch and you need cash to meet your day-to-day responsibilities.

How SMEs are turning unpaid invoices into cash more quickly

Manufacturers, wholesalers, retailers, distributors and service-based businesses often have a lot of operational cash flow tied up in unpaid invoices (accounts receivables).

Either through payment terms, timing, lateness or other factors, the cycle of cash coming into the company gets out of sync with the timing of expenses, like payroll, rent, utilities and the cost of materials.

Both invoice factoring and invoice financing were developed as solutions these kinds of short-term cash flow problems.

Many SMEs need better short-term options to fund wages, purchase materials or just pay the bills

Invoice factoring vs invoice financing: What they are  

Invoice factoring and financing are two forms of asset-based lending. In both cases, the assets you’re leveraging are your unpaid invoices. The main difference is who collects the final payment from the customer.

With invoice factoring (accounts receivable factoring), the lender (factor) purchases your invoice by paying you a percentage of the outstanding amount (invoice discounting). The factor then handles the process of collecting the invoice payment. Once the customer pays the factor, the remaining amount is factored back to you — minus any fees and a set percentage for the transaction.

With invoice financing, your invoice is the collateral and the lender pays you a percentage of the invoice. In this case, you handle getting payment from your customer. Once your customer pays you, you pay the lender back — with fees and interest included. Depending on your arrangement with the lender, you may receive a final cash sum once you pass along your repayment.

The factoring industry, including both invoice factoring and invoice financing, is a $3 trillion business

Read More: Cash Flow 101. 

How the fees and percentages are determined for invoice factoring and invoice financing

When you research choosing invoice factoring vs invoice financing, you’ll see a range of percentages and rates for processing fees.

The lender sets the processing fee. The percentage you’ll receive from your invoice is a function of the size of the invoice and how the lender views your business and your customer’s business in terms of risk.

The better your business’ financial health and risk profile, the higher percentage you’ll receive when either factoring or financing your invoices.

Invoice factoring vs invoice financing: How the difference affects your business

Because the factor takes over the burden of collecting payment, invoice factoring can really help small businesses that simply don’t have the time to chase down outstanding invoices.

The counterpoint is that your customers may find out that you’re using a factoring service when they’re contacted for collections.

If you prefer to keep control over your collections processes, you may opt for invoice financing over invoice factoring.

Invoice factoring vs invoice financing: How do you choose?

The choice always comes back to what’s right for your business. It’s possible that your customers may not be bothered by invoice factoring if you take the time to communicate with them in advance of factoring the invoice.

But, maybe you just prefer to be the one to control the collections. Or, maybe the lender you prefer only offers one or the other. In the end, it’s all about your personal comfort level.

The benefits of invoice factoring and financing

The approval process for both invoice factoring and invoice financing is faster and friendlier. This is especially helpful for new businesses with only a few years of financial history, businesses who need cash quickly and those who don’t want to gather every form of documentation since the stone age.

Unlike traditional loans that have multiple payments structured in regular intervals spread over several months or years, with invoice factoring and invoice financing you only pay the fees once per invoice. There are also only two payments: You get the bulk of your cash when the invoice is factored or financed and the remaining balance when the invoice is paid.

Learn More: How to Read a Cash Flow Statement.

How long have invoice factoring and invoice financing been around?

As long as there have been businesses supplying services, goods and materials, there have been businesses waiting to be paid.

In fact, asset-based financing dates back to early Mesopotamia during King Hammurabi’s time. This kind of short-term business lending helped fuel the textile industry during the industrial revolution. Asset-based lending continued to gain traction in modern economies as traditional lending models tightened.

Today, the factoring industry, including both invoice factoring and invoice financing, is a $3 trillion business.

What’s next for asset-based lending?

That’s where PayPie comes in. We will transform the way businesses and lenders connect by using blockchain technology to securely and easily trade information. A single ledger technology, blockchain is a way for businesses and lenders to share the same information in near real-time.

As we’re laying the groundwork for our business financing opportunities, we’re also providing sophisticated cash flow forecasting and risk assessment that gives each business a better idea of where they stand in terms of cash flow. (Click here to be notified when our financing solutions are available.)

Get your free cash flow forecast

Our insights and analysis are free. Your dynamic report will give you all the charts and graphs you need to understand the crucial elements affecting your cash flow. It will also contain a proprietary risk score showing how potential lenders might evaluate your business in comparison to others.

If you’re a QuickBooks Online user, all you have to do is sign up for PayPie then connect your account. (Future accounting platform integrations are coming soon.)


PayPie Cash Flow Forecast Example

This article is informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.

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Author: Michelle Mire

When not overseeing the PayPie Blog or writing about cash flow and business financial health, Michelle can be found working on her own health by going out for a run.