Invoice factoring vs. Invoice Financing: What You Need to Know

Ezra Cabrera

August 6, 2021

Key Takeaways

➥ Both invoice factoring and financing can free up cash tied up in your invoices. The major difference between the two lies on who owns the invoices at the end and collects the customer’s payments.

➥ In invoice financing, the company (borrower) retains ownership of the invoices and collects the customers payments. With invoice factoring, the company (borrower) sells the invoices to third-party factoring companies who, then, collects the customers’ payments.

➥ Invoice financing would be a suitable choice if you have the resources to collect the payments yourself and you’re confident that your customers will pay their dues. On the other hand, invoice factoring may make more sense if you need outside help when collecting payments.

Unfortunately, unpaid invoices are an inconvenient reality for small business owners offering net terms to their customers. “Net term” refers to invoices with a specific payment period (30, 60, or 90 days).

If most of your capital gets tied up in your accounts receivables, your company can experience cash flow gaps that make it harder for you to manage your finances. On top of that, banks are notoriously known to have strict qualifications when it comes to small business loans. As a result, SMB’s have a tougher time securing additional funding to sustain their operations or invest in business opportunities.

Fortunately, invoice financing and factoring are available to small businesses. These small business financing options allow companies to free up cash tied up in their invoices. That way, they will have more capital to sustain their operations and invest in business opportunities.

So, what’s the difference between the two financing options? Here’s everything you need to know about the similarities and differences between invoice financing and invoice factoring.

What is Invoice Financing?

Invoice financing, also known as accounts receivables (A/R) financing, allows businesses to use their customer’s outstanding invoices to get additional funding for their business. In most cases, the financing company can fund up to 80% of the total amount of the accounts receivables.

Once approved, the invoice financing provider advances the funds to you by transferring the entire loan amount to your account or through a line of credit.

When the invoice terms are up, you (the business) will be in charge of the payment collection. After your clients settle their accounts, you’ll have to pay the advanced amount (plus interest and fees) back to the invoice financing company. The interest rates for invoice financing vary by provider. In general, the total fees will range from 1% to 3% per month.

Some invoice financing companies may also connect with your company’s accounts receivables system and automatically deduct the payments once the customer pays their balance.

Invoice financing is an excellent choice for companies with enough resources to handle the payment collection from their customers. Additionally, your customers won’t know that you’re working with an invoice financing company since they will be paying you directly.

What is Invoice Factoring?

Invoice factoring works a lot like invoice financing in that the business owners borrow money against their customer’s outstanding invoices. Eligible companies typically receive around 85% to 90% of their total unpaid accounts receivables

Unlike invoice financing – where you’ll retain complete control of the ledger –the factoring company (or factor) will purchase the invoices and take hold of your company’s accounts receivables. This means that the factor will also be taking over the payment collection.

Once the invoices term is up, the clients will pay the invoice factoring company instead of the business. As soon as every outstanding customer’s invoice has been settled, the factor deducts the advanced amount, along with the agreed-upon interest rate and fees, before forwarding the balance to the borrower.

Since the factoring company will be taking over the payment collection, the customers may be aware that your business uses invoice factoring. Although this isn’t a bad thing, some companies might be uncomfortable with their customers being aware of their relationship with the factoring company. This is why many will prefer invoice financing over invoice factoring.

Some factoring companies may also conduct the payment collection as discreetly as possible. They may introduce themselves as representatives of your company, so the clients won’t know that you’re working with an invoice factoring company.

If you do end up choosing invoice factoring over invoice financing, know that factoring typically comes with higher interest rates than invoice financing. Since the factors will take responsibility for the payment collection, they will set the bar higher for the extra effort. Plus, there’s the possibility that the customers might not pay the invoice, so the factoring company will charge more to offset the risk.

That said, expect to pay between 2% to 4.5% in interest with invoice factoring services. This is significantly higher than invoice financing services which typically have a maximum interest rate of 3%.

Invoice Factoring vs. Invoice Financing: Summary of Differences

Here’s a snapshot of the differences between invoice factoring and invoice financing:

Invoice Factoring
Invoice Financing
2% to 4.5% per month.
1% to 3% per month.
Typical amount advanced
Up to 90% of the total invoices financed.
80% of the total invoices financed.
Payment collection
The customers will pay the factoring company.
The customers will pay the business.
Invoice ownership
The factor purchases the invoices, and therefore, owns them.
The business retains full control of the accounts receivable ledger.

Invoice Factoring vs. Invoice Financing: Which One is For You?

When you’re in a cash squeeze, invoice financing and factoring can both be a great alternative to hard-to-qualify bank loans. So how do you know which one is better for you?

Generally, invoice financing will be a better choice than invoice factoring, if:

➥ Your company is capable of collecting customer’s payments without outside help

➥ You’re looking for a more affordable financing option

➥ You want more flexibility when it comes to choosing which invoice to finance

➥ You don’t want your customers to find out that you’re using the services of an invoice financing company

Invoice factoring is an excellent choice under the following circumstances:

➥ Your invoices have a term of 60 to 90 days or longer

➥ You want to offload the responsibility of retrieving the payments from your customers

➥ You don’t have the resources to collect the customer payments yourself

➥ You’re comfortable with the fact that your customers might know that you’re using a factoring company

➥ You can afford the high-interest rate and fees

Ultimately, the best option will depend on the needs and current situation of your business. How much can you afford? Will you need assistance in collecting the payments? Ask yourself these questions before fully committing to the financing

Invoice Financing vs. Invoice Factoring: Advantages and Disadvantages

While the two financing options do vary in terms of how they’re structured, they share the same advantages and disadvantages. Let’s explore both sides of the coin below.

Advantages of Invoice Financing and Factoring

1. Solves slow cash flow

Some invoices will have a repayment period of 90 days. Instead of waiting for the customers to pay you, you can use invoice financing or factoring to free up much-needed capital tied up in the accounts receivables. That said, you won’t have to worry about late debt payments, payroll, or missing out on a time-sensitive business opportunity.

2. Easy to qualify for

Invoice financing and factoring are usually the go-to financing options for businesses that can’t qualify for a conventional long-term loan. This is because they’re two of the most accessible financing options.

With this type of financing, the lenders will look at your credit score, but it won’t be their primary consideration for approval. Invoice financing and factoring companies typically care more about your customer’s credit standing since the repayments will largely depend on their credit behaviors. So, if you’re planning to apply for invoice financing or factoring, you will have to make sure that your clients are creditworthy to increase your chances of getting funded.

3. No more worrying about late payments

If you’re constantly dealing with late payments, invoice financing and factoring remove the headache of having to worry about slow cash flow in your business. With invoice financing, you can get as much as 80% of funding, while invoice factoring can offer up to 90% cash advance to eligible businesses. This ensures that you have a steady flow of cash to meet your monthly financial obligations on time, like payroll, rent, utilities, and debt repayments.

4. No additional collateral needed

With invoice financing and factoring, your accounts receivables will serve as the asset that will secure the funding. That means you won’t have to present additional assets to use as collateral for the loan. Businesses in their early stages of operation will find invoice financing and factoring a valuable financial resource to get the capital needed to keep their business afloat.

Disadvantages of Invoice Financing and Factoring

1. It can be expensive

The fees associated with invoice financing and factoring tend to be higher than traditional bank loans or long-term loans. The interest rates may also be higher, depending on your customer’s credit standing. In general, the interest rates will range from 2% to 4.5% for each month that the invoices remain unpaid. Some financing companies may even charge weekly fees for the outstanding invoices.

2. You’ll have to cover the payment for the unpaid invoices

If, for some reason, your customer defaults on their invoices, there’s a high possibility that the providers will hold you responsible for the repayment. In that case, you might have to pay the financing company out of your pocket. This could be a major disadvantage, especially if you’re already experiencing cash flow issues and the unpaid invoice is significantly large.

Businesses that Commonly Use Invoice Financing and Factoring

Essentially, any business that offers net term payments can apply for invoice financing or factoring. These particular businesses are more prone to cash flow problems because of unpaid invoices.

Companies that typically apply for invoice financing or factoring most commonly fall into these industries:

➥ Manufacturing

➥ Construction

➥ Recruitment/Staffing

➥ Transport

➥ Export

➥ Security

➥ Logistics

➥ Wholesale

Where to Apply for Invoice Financing and Invoice Factoring

If you decide to pursue invoice financing, choosing the right financing company to work with is vital. Not only does this ensure that your application process goes smoothly, but it will also guarantee that you’re getting the best terms possible for your current situation.

If you’re in the process of finding the right invoice financing and factoring company, these options are worth considering:

1. BlueVine

BlueVine offers both invoice financing and factoring to small businesses. One of their biggest advantages is that applicants can complete the application from start to finish online.

With BlueVine, businesses can fund invoices with amounts ranging from $20,000 to $5 million. The company can advance up to 90% of the total amount of the invoices and get the funding within 24 hours after approval. The BlueVine application process usually takes around two to seven days to complete.

It’s worth noting that BlueVine does charge a 0.25% to 1.7% interest rate per week on the unpaid invoices, which might be higher than other providers.

Another feature that makes BlueVine an excellent choice is the non-notification. They handle payment collections discreetly, so your clients won’t know that you’re working with a factoring company (if you’re applying for invoice factoring). That said, they may introduce themselves as a representative from your company when collecting payments.

If you’re interested in applying from BlueVine, you’ll need to meet the following requirements to increase your chances of approval:

➥ A credit score of at least 600

➥ Must be operating for at least six months

➥ Minimum annual revenue of $120,000

2. Fundbox

If you’re interested in applying for invoice financing, Fundbox could be the right choice for you. Unlike BlueVine, Fundbox doesn’t set a minimum credit score for qualification. They also forego any minimum annual revenue requirements. As long as you can prove that your business is capable of paying the advanced amount back, you’ll have a shot at qualifying for their invoice financing product.

Fundbox also charges lower fees than BlueVine. Specifically, they charge around 0.5% to 0.7% per week.

To apply for their invoice financing service, all you have to do is grant Fundbox access to your accounting or payment management software. From there, the financing company will evaluate your business’ health and performance. They will then decide whether you’re worth the credit risk or not.

Once you’re approved, you can get as much as 100% of the total value of your invoices. You can then access these funds through the credit line. Since it’s invoice financing, you will be in charge of the payment collection from your customers. You will then have to pay a portion of the borrowed amount, plus the fees, every week until you’ve paid the entire advanced amount in full.

3. AltLINE

AltLINE is a commercial financing division of The Southern Bank. Although they primarily work with staffing and consulting agencies, they also provide their invoice factoring services to government contractors, manufacturing, and distribution businesses.

With AltLINE, you can get your invoices amounting to $4 million funded. You can apply for their services online and get your business funded within 48 hours after approval.

However, if you decide to pursue AltLINE’s invoice factoring services, know that they charge a 0.5% to 3% fee on the invoices that remain unpaid in the first 30 days. This fee increases every 15 days, but AltLINE maxes out at 5%.

To be eligible for AltLINE’s invoice factoring, you must meet the following requirements:

➥ Be able to factor at least $15,000 per month with them

➥ Have a credit score of at least 500

➥ Have creditworthy customers

➥ No more than two or more bankruptcies

➥ No history of loan default

Invoice Factoring vs. Invoice Financing: Frequently Asked Questions (FAQ)

1. What documents do I need to prepare?

The documents and paperwork you need when applying for invoice financing will vary by lender, but it will definitely be less than what you’d need to prepare if you were applying for a conventional loan from a bank.

That said, if you’re applying for invoice financing or factoring, here’s a list of documents the lenders will typically ask for from the applicants:

➥ Driver’s license

➥ Voided business checks

➥ Business bank statements

➥ Business financial statements

➥ Personal and Business credit scores

It’s possible that the financing or factoring company may require you to submit additional documents, like business leases or other contracts, but this is rare. Be sure to ask the financing company’s representative what you may need so you have everything prepared in the event that they ask for something last minute.

2. How long will it take for the funding to reach my account?

Alternative and online lenders typically offer invoice factoring and financing. Their application and approval processes are faster than that of banks. In general, the earliest time the funds reach your account will be 24 hours after approval.

3. Is it possible to work with the invoice financing or factoring company again?

Yes. One of the biggest pros of invoice financing and factoring is that you’ll get to establish a lasting relationship with your provider. As long as you pay on time, your chances of getting approved for financing again will be higher. Moreover, other providers may even strive to stay on the good side of their clients to increase their chances of doing business with them again in the future.

4. When do I have to pay the loan back?

This will depend on the lender you’re working with. Some may require you to pay the cash advance back within a specific time frame (usually 12 to 24 weeks), while others may allow you to pay once the customers settle the account, which is 30, 60, or 90 days depending on the terms you established. Of course, this is only applicable to invoice financing as invoice factoring companies usually deduct the payment for the borrowed amount once the customers settle their balances.

5. What happens if the customer doesn’t pay their invoice?

Some factoring companies will hold the business responsible for paying back any invoices that they can’t collect payments on. This is referred to as recourse factoring. In this case, you will have to dig into your personal or business savings to pay for the unpaid invoices. However, if you and the factor agree on non-recourse factoring, the factor will take full responsibility for the non-repayments and shoulder the loss.

The Bottom Line

Invoice financing and invoice factoring are two valuable financing resources that businesses can take advantage of. While they may differ in some aspects, both options are a great solution to solve cash flow issues brought about by unpaid invoices.

When choosing which one best suit your business best, consider your business’s current needs and situation. If you’re confident that you’ll be able to collect payments yourself and want to keep complete control over your invoices, then invoice financing would make more sense. However, if you’re short on manpower to chase payments from customers and don’t mind paying higher fees, then invoice factoring would be a viable choice.

Now that we’ve covered the differences and similarities, you’ll most likely be able to make an informed choice regarding what type of financing best suits your business. Use this as a guide to start improving your business’ cash flow today.