If you own a small business and have faced slow-paying customers or other cash flow gaps in the past, chances are that you’ve at least heard of invoice factoring or invoice financing. These two terms are often used interchangeably. While they are similar and are both ways to get business financing, they’re actually not the same thing at all.
Invoice factoring and invoice financing have some key similarities, but they can differ widely when it comes to how much control you have over the process, what type and amount of fees you need to pay, and the way your choices affect your customers.
We’ll cover some of the key differences so you can make the best choice when it comes to getting fast funding for your business.
An Overview of Invoice Factoring
The basic process for using invoice factoring and invoice financing is very similar. Both involve accessing funds based on your current outstanding business invoices. With either option, you may run into slightly different agreements and stipulations depending on the company you choose to work with. Factoring has been around quite a bit longer, so there are more companies out there offering the service, and a wider variety of different options you may encounter.
When you choose a factoring company to work with (also simply called a “factor”), you’ll need to apply by sharing your business transaction history and credit history with them. They will probably ask for your business documents and, in most cases, perform a credit check on you. The process is similar to what happens when you apply for a traditional loan but can go a bit faster if you’re working with an online factor and you’ve got your documents organized already.
If you’re approved for factoring, the next step would be your factor agreement. The factor will send a contract for you to sign, describing all the fees, the details of the payment plan, and the amount of funding you’ll receive. You’ll need to be on the lookout for many different fees and variables.
Given all the details involved, the agreement step is really important. It’s not unusual for business owners new to factoring to bring in a financial advisor or lawyer to go over the agreement with them to be sure they understand and can abide by the terms.
After you sign a factoring agreement, the factor will give you what’s called an “advance.” Generally, this is a percentage of the total amount of the invoices you’ve decided to sell. The rate you get will depend on your agreement terms, your industry, transaction history, and other factors that the factor determines. At this point, the factor generally takes over collection on those invoices, meaning that your customers will be hearing from the factor from now on—not from you.
The Basics of Invoice Financing
Similar to factoring, invoice financing is a popular method for business owners to unlock funds that are trapped in their accounts receivable. The invoice financing process is usually a bit simpler.
You’ll need to apply for invoice financing, but unlike with most invoice factors, you can typically complete the process online, without any paperwork. In many cases, you won’t need to include many business documents or maintain a certain minimum credit score to be considered. Similar to factoring, you’ll usually need to provide your business transaction history.
If you’re approved, you’ll start to see more differences between factoring and invoice financing. With invoice financing, the fees and payments are straightforward. For example, instead of receiving funds for a percentage of your invoices, with Fundbox invoice financing, you get 100% of your invoice value up front, then pay it back with flat weekly installments, plus a fee.
With invoice financing, you’ll also remain in charge of collecting payment from your own customers. Instead of reassigning the invoices to a third party, as in factoring, with invoice financing you continue to invoice your customers as usual.
This can be an important benefit for some business owners since it means there is no change to the relationship with your clients. If you finance your invoices, your customers never need to know, and they don’t have to worry about changing anything about who or when they pay.
Invoice Factoring or Invoice Financing: Making A Choice
That issue of who communicates with your customers can be a dividing line for business owners considering invoice factoring or invoice financing to get access to business capital.
On the one hand, if you often feel pressed for time, have a small team, and would like to offload some of your billing and collections responsibilities, the idea of having a third party step in and take those over for you might sound wonderful. If you have many customers who are difficult to contact and slow to pay, it can be a relief to let someone else deal with the situation while you get funds up front—even if you aren’t getting 100% of your invoice value.
On the other hand, if you work in a service-oriented business, you might not feel so good about letting a third party get between you and your clients. If you are concerned about providing a certain level of customer service, you may not want to lose or change those relationships with your clients.
In the end, both invoice factoring and invoice financing can be helpful ways to get quick access to capital to operate and grow your business. Your business priorities and situation will point you in the right direction.
The SmallBizRising Blog is designed to be an educational content hub pulling information, best practices and practical advice for the small business owner and features topics including accounting, marketing, technology and more. Be sure to subscribe to stay up to date with new content as it is posted. The blog was created by The Neat Company and receives contributed content from a group of contributing companies that provide technology, services and solutions to small businesses.