Invoice financing, also known as accounts receivable financing, is a financing option where a merchant sells their outstanding invoice to lenders in exchange for a lump sum of money. This type of financing is mainly used to improve cash flow, pay for the employees’ salaries, or invest in business growth opportunities without having to wait for their clients to pay their outstanding invoice in full. When it comes to financing your invoices, you can choose between two invoice financing options: Invoice factoring and invoice financing.
A lot of businesses can benefit from invoice financing. Although invoice financing and discounting works similarly, they do have differences that make them distinct from each other.
What is Invoice Factoring?
In invoice factoring, you’ll still be selling your outstanding invoice to lending companies (the factor). Clients often pay their outstanding invoices within a month or two after their purchase and this puts a strain on the merchant’s cash flow. With invoice factoring, the lending companies pay the merchants 70 to 80 percent of what the invoices are worth. Once the clients pay the values in full, the lenders will then give the 20 percent or 30 percent of the paid invoice back to the merchants minus the interest rate and fees.
In this type of financing, the factors are usually the ones that collect the money from your clients. Once you get your cash from the lenders, they will then do the job of making sure that your clients’ invoices will be paid. This means that they will be the ones who will manage and process the payments. This arrangement lets your clients know that you’re working with lenders for invoice financing.
What is Invoice Discounting?
In the same way as invoice factoring, invoice discounting still allows the merchants to sell their outstanding invoices to lending companies in exchange for cash upfront. But unlike invoice factoring, merchants are mainly responsible for their sales ledger, payment chasing, and invoice processing. In this type of invoice financing, your clients are not aware that you’re working with lenders. Once the invoice is fully-paid, the merchants will then pay the lender what they owed plus the fee and interest rate.
What’s the Difference between the Two?
While both options provide the merchants with upfront cash to maintain stable cash flow, there is a lot of difference that distinguishes them from one another.
- Control of Payments
When you apply for invoice factoring, the lending companies take over the management of your invoices. This means that they will be the ones to chase the clients with outstanding invoices. In this way, you’ll be relieved of the duty of doing it yourself. You also won’t have to undergo the tedious process of determining the credibility of your customers. With invoice factoring, you can pass the responsibility of invoice payment to the lending companies.
Merchants who want full control of the money that comes in from outstanding invoices are more likely to benefit more from invoice discounting. This type of financing option allows the owners to take full control of their sales ledger and collect the payment themselves from the clients.
Because the lending companies are in charge of invoice payments, most of their customers will be aware of the arrangement between the merchant and the lender. Discounting, on the other hand, allows merchants to take control of the entire process so the customers will be unaware of the discounting agreement between the merchants and lending companies.
- Company size
Invoice factoring is usually the option best for small businesses that don’t have enough staff to chase down payments. Although there’s a higher fee involved in factoring, it’s a worth it investment considering that you won’t have to deal with payment chasing.
Invoice discounting, on the other hand, are usually for larger companies that have enough resources to collect payments from their clients. And because they will be doing the entire process themselves, lenders will usually impose lesser fees and interest rates.
With invoice factoring, merchants can choose which outstanding invoices they want to finance. They can get as much as 85% of the invoice they submitted which helps improve the company’s cash flow. In invoice discounting, the company has to submit all their outstanding invoices and the lenders will then agree to a certain percentage of the total value of the submitted invoices.
The Benefits of Invoice Financing Options
Despite the many difference, both options do offer the same benefits. With either invoice financing option you can:
- Receive the cash your company needs within 24 hours.
- Secure the funding even if without a hard asset as collateral.
- Obtain cash needed to solve or avoid cash flow issues in your business.
- Pay suppliers in advance and increase your chances of getting goods at discounted prices.
Aside from the listed benefits, invoice factoring and discounting is also a great financing alternative if you’ve been rejected for term loans. Because invoice financing doesn’t usually look at a person or business’s creditworthiness, it’s a good option that favors businesses with bad credit.
Which Invoice Financing Option is Right for You?
Before you decide on what’s invoice financing option is right for your business, be sure to do your homework first. Although both options are essentially the same, some differences might or might not make it the best fit for the business you’re running. To be sure, ask the experts for help. They are more than qualified to provide you with a lot of insights when it comes to choosing the best financing option for your company.