Invoice Factoring vs Invoice Financing

invoice factoring vs invoice financing application image

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.

Image via Pexels.

 

Cash Flow Problems: 6 Top Causes

cash flow problems top causes

Many small businesses are only one late invoice away from a cash flow crisis. They face serious risks of losing everything they’ve worked so hard to build. One of the biggest reasons small businesses fail is due to cash flow problems.

Time and again, study after study shows that when a business fails, it’s due to poor cash flow. Twenty-two percent of small businesses say that cash flow is a challenge. That’s a pretty sobering thought.

Cash flow has the biggest impact out of almost anything else you can imagine. Fortunately, there are certain factors that lead to cash flow issues or a cash flow crisis. Knowing these factors lets you better protect your business.

This is the reason why PayPie wanted to provide you with six of the top causes of cash flow problems you’ll want to avoid.

Read More: Reporting, Cash Flow and Your Business’ Financial Health.

1. Lack of an Emergency Fund

No matter what type of business you run, there will be times when business booms. There will also be times when business stutters. When cash flows in, set some of the profit aside in an emergency fund.

You never know what life might throw your way, so having enough funds to cover a catastrophe is smart. If you’re one late invoice from failing — imagine the relief of having an emergency fund during to respond to unexpected cash flow problems.

Ideally, you should start your business with enough funds in place to cover emergencies, unexpected expenses and cash flow issues. However, if you’re already in business, you might not have planned for such a fund. In this case, throw every extra bit of money you can into your emergency fund until you have enough to cover any major issue.

2. Poor Invoicing Practices

Keep cash flowing into your business by invoicing on a schedule and following up on unpaid invoices. Most business people become so busy building their businesses they let paperwork fall behind, which can lead to cash flow problems.

If you don’t invoice your customers, they aren’t likely to pay you. Even if you have invoiced them, you may need to follow up. Remember they are busy, too.

You may also want to run a quick credit check on new clients. If they have poor credit, request at least a portion of the payment up front and as the work is completed. If you can’t keep up with invoicing, try investing in a virtual assistant to keep up on such matters for you. Online software also allows you to automate invoicing and reminders for unpaid invoices.

3. Unsynced Credit Terms

When setting up the credit terms for your customers, you also need to look at the credit terms from your suppliers. If your suppliers offer net-30 and you offer your customers net-60, you’ll likely encounter cash flow issues. Net-days can translate to nearly any number. Some suppliers only offer 15 days  (net-15), for example. Seek suppliers with the most generous net-days terms you can find.

Take the time to study your books and discover what terms each of your suppliers offer. Your terms to your customers should be less than the shortest payment time to your suppliers. This gives you some room in case your customer pays a bit late. The last thing you want is to owe your supplier well before your customer owes you.

A free cash flow forecast from PayPie will also give you insights into your accounts receivable cycle. Armed with this information, you can help anticipate and prevent a future cash flow crisis.

4. Growing Pains

Growing at a rapid pace is something every business owner dreams of. Then it happens, and you realize you don’t have the funds to supply that growth. Imagine a scenario where you’re mentioned by a social media influencer.

You suddenly have 100 new customers you didn’t have last month. Where does the money come from to buy the goods to supply those customers or pay the employees to provide a service?

When you gain an influx of new customers all at once, you then have to supply those customers. But, you haven’t been paid by them yet.

One way to avoid this is to change your terms before the growth hits. Ask for at least some payment up front before you send items to customers or begin work. Make sure it is enough to cover your expenses. When the customer pays the remainder of the invoice, you’ll get your profit. It’s easier to wait on profit than to hit negative numbers on the books.

Read More: Cash Flow Forecasting: What You Need to Know.

5. Not Monitoring Expenses

Over time, expenses creep in that you might not have budgeted for. Perhaps a supplier raises their prices, and you’re too busy to seek a new supplier. Perhaps your monthly rent goes up, and it’s too much work to move to a new location.

Whatever the cause of these creeping costs, if you don’t monitor them closely, the resulting cash flow problems can potentially overtake your business.

At least once per quarter, take the time to sit down and review your costs. Look at wages, supplier costs, rent and even things such as utilities. Where can you cut down on the costs or implement policies to reduce expenses?

6. Not Planning for Seasonal Fluctuations

Every business on the planet has slow seasons. For retail establishments, this is traditionally January and February. For other industries, it might be the winter months or the summer months or anything in between. Not planning for these fluctuations leaves you with unneeded inventory and lack of funding.

Don’t wait for the fluctuations to cause cash flow problems. Plan ahead. If you know that winter is slow for your business, then cut back on inventory the month or two before the slow season hits. Plan promotions ahead to up your income during these months, or use the time to travel to trade shows and drum up new business and clients.

Cash Flow Woes

Almost every business experiences cash flow problems at some point. Knowing the causes of cash flow issues allows you to avoid the inevitable pitfalls. With a little pre-planning and a lot of organization, your business will run like a well-oiled machine.

Instead of stunting your growth or killing your business entirely, overcoming a cash flow crisis gives a competitive edge by realizing the value of having plans in place.

Wondering just how much cash flow you need to keep your business healthy and thriving? PayPie offers cash flow forecasting.*

Get a free cash flow forecast today and get a handle on problem areas before they become a financial crisis.

We’d personally like to thank Sarah Landrum of Punched Clocks for contributing this post.

*PayPie currently integrates with QuickBooks Online. Additional integrations are coming soon.

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