selling invoices to improve cash flow is becoming a very popular business practice but keep in mind that there are different types of companies that you can sell these invoices to.
invoice factoring and invoice financing is often used interchangeably but they’re not the same thing so today we’re going to explore just what makes them different.
first, let’s take a look at what these two things have in common so if you have outstanding receivables and you’re facing cash flow problems whether it’s an invoice financing company or an invoice factoring company you can sell these invoices to them for cash up front.
invoice financing and invoice factoring share a lot of advantages for example you won’t have to go through a credit check because it’s more important how likely your customers are to pay back also you won’t have to put up any collateral because the invoices serve as collateral themselves we also tend to receive the cash pretty fast usually within a couple of days you no longer have to wait for your customers to pay you back because you get that cash you can immediately put it back into your business.
What is Invoice Factoring?
now let’s talk about what makes each of these types of financing unique starting with invoice factoring, how does invoice factoring work, well to begin the factoring company will purchase your outstanding receivables, and then they’ll give you an immediate cash advance usually at the amount of a large majority of the total invoice balance then they take over the actual collection of the invoice so you don’t have to worry about reaching out to your customers to get them to pay and then once the customer has paid they return the rest of the remaining balance minus their fees.
any business that has outstanding receivables can be a good candidate for invoice factoring the things they’re gonna look at are going to be things like the total amount of your invoice if you have larger invoices that are great but if you have smaller invoices it might be hard to factor those as well they’re going to look at the creditworthiness of your customers because they don’t want to advance you cash for someone likely not to pay you back.
the most confusing part of invoice factoring is the fees associated with it so let’s take a deeper dive into this, usually, the factoring company will advance around 80% of the outstanding invoice total and keep the remaining 20% and from that, they for sure take their process which is a flat fee for doing the job it’s usually around 3% and then from there, they charge this called a factor fee which is a percentage rate based on the total amount of time that the invoice is outstanding so for some factors they do it daily others weekly so they charge a percent either per day or per week the invoice is outstanding and then once the customer pays the invoice they hand over the rest of that reserve amount minus their fees.
to make it easier to understand let’s look at an actual example, let’s say you sell a hundred thousand dollar invoice to the factoring company so they upfront you eighty thousand dollars and hold on to the remaining twenty thousand dollars and then take the customer two weeks to pay back so when they do pay back the factoring company takes their three thousand dollar fee plus their two thousand dollar faculty because they charge you 1% per week that they help the balance meaning that they pay you back fifteen thousand dollars at the total reserve hold on to five thousand dollars as their feet.
hopefully, that helped to clarify just a bit, and let’s take some time to review everything we’ve learned about invoice factoring first of all the great things are that you get quick access to cash your invoices or the collateral and it’s okay if you have bad credit but the cons are that you’re gonna have to pay higher fees than you live the traditional form of financing you’re going to lose a portion of the profits you were supposed to earn and if your customers pay late it will cost you more.
What is invoice financing?
we’ve mastered invoice factoring let’s take a look at what makes invoice financing unique.
how does invoice financing work well to begin the financing companies will lend you money based on your outstanding receivables we’ll charge you a monthly fee for the actual service and an interest rate for the amount you borrow and then you’ve retained control over the collection of the invoice.
this type of invoice financing is going to be harder to qualify for it tends to be better for larger businesses that happen a number of receivables on their books as an is an ongoing relationship so the finance company is going to require things like regular reports on the sales ledger so they can determine how much to lend you ongoing and also regular reports on your credit control process.
the fees associated with invoice financing are much more simple than with factoring what they’ll do is will allow you to borrow up to around 80 percent of your outstanding invoice portals and then they’ll charge a monthly fee for the actual surface and then the interest rate on the amount that you borrowed.
let’s look at another example to clarify now the best way to think about this is it’s like a revolving line of credit collateralized by your invoices so if you have a hundred thousand dollars worth of outstanding invoices that means the finance company is going to allow you to borrow up to about eighty thousand dollars so your customers are paying you directly and as your outstanding receivables change the total you can borrow also changes unfortunately so for this month you would pay fifteen hundred dollars which is a 1.5% management fee on the total amount of outstanding invoices and let’s say you also pay thirty-four hundred dollars which is the interest on the lent amount let’s say it’s prime plus one percent for the month.
so definitely a bit easier to understand than factoring fees but to recap invoice financing some great things about it are the ongoing access to cash just like a line of credit the invoices again serving as collateral and lastly getting to maintain that relationship with customers when it comes to collecting this invoices but some things you want to watch out for are the smaller profit margins not being able to qualify for this type of business and lastly in affecting your ability to borrow traditionally.
invoice factoring vs invoice financing
so let’s review invoice factoring versus invoice financing with invoice factoring you’re gonna sell your outstanding invoices in exchange for cash up front most businesses are going to qualify what matters most is the amount of the invoice this is gonna save you time on managing collections as the factoring company will take over the collection of the invoice.
for the invoice financing or discounting think of it like a rolling line of credit that is collateralized by your invoices, it’s going to be harder to qualify for this type of financing but it is an option that allows you to keep collections in-house as the customers will pay you and you will pursue them for payment.
these are just two options available to businesses that want to use their invoices to secure cash there are also a lot of online options available like a company called funbox or company called bluevine but no matter what if you’re considering using invoices to prove your cash flow research your options and understand the differences.