Invoice Factoring vs Invoice Finance. What are the differences?

Updated On June 8th, 2022By Grow Finance

Invoice financing and invoice factoring are both beneficial options for businesses when it comes to maintaining a steady cashflow. Both options allow businesses to continue operations and focus on growth and productivity, without having to wait for overdue accounts to be paid. Although similar, it is important to understand how each option works before choosing the right one for your business.

What is invoice factoring?

Invoice factoring is when a business sells its unpaid invoices at a discount to a third party factoring company. The factoring company pays the business a percentage of the invoices upfront, which helps to free up cashflow. The factoring company then becomes responsible for collecting on the invoices.

Once the invoices have been paid in full, the factoring company will reimburse the business the difference, minus the fees and charges. Invoice factoring works differently to invoice finance, as the business’s clients make their repayments to the factoring company, rather than the business itself.

How does invoice factoring work?

1. Businesses provide products or services to their customers as per normal.
2. They then invoice the customers for the goods or services supplied.
3. The business then sells the invoices to a factoring company. Once they have verified the invoices are valid, they pay the business the majority of the total invoiced amount (normally up to 80-90%) upfront.
4. The customers then deal with the factoring company paying them directly for the invoices. The factoring company is also responsible for chasing payments.
5. Once all invoice payments have been made in full, your business will be paid back the balance of the invoiced amounts, less the factoring company’s fees and charges.

Invoice factoring in practice

A business looking to cover cash shortfalls chooses to use invoice factoring for $80,000 worth of invoices all on 30-day terms. The factoring company they are using then pays them $64,000

(80% of the value) of the outstanding invoices upfront.

The factoring company charges the business 1.5% each week that its customers take to pay their invoice/s. All customers pay the outstanding invoices in full on the 30-day payment terms. The invoice factoring company’s total fee of 6% or $4,800 (1.5% x 4) is deducted from the balance. The business is then paid the balance of the outstanding $16,000, less the $4,800 in fees, receiving a total of $11,200.

In total, the business receives $75,200 of the original $80,000.

What is invoice finance?

Invoice finance is also a financial service provided by a third party. However, instead of a business selling their invoices, they apply for invoice finance. Invoice finance is essentially a short-term loan that allows businesses to secure up front funds for their operations, without having to dip into their cash reserves, whilst waiting for invoices to be paid. Invoice financing is secured by using the invoices as collateral. Most providers of invoice finance will lend up to 80% of the value.

Unlike invoice factoring, the invoices remain with the business, including chasing and collection of payment. Invoice finance frees up working capital allowing businesses to continue to manufacture and produce without having to worry about unpaid invoices. When a payment is made on time, the provider of the invoice financing is compensated for lending and the transaction is complete.

Invoice financing in practice

A business looking to cover cash shortfalls chooses to use invoice finance to cover $80,000 worth of unpaid invoices, all on 30-day terms. The chosen invoice financing lender gives the business a loan for 80%, or $64,000 of the total invoice value upfront.

The lender charges the business 5.95% for every month that the invoices remain unpaid. The business’s customers all pay within the 30-day invoice terms. As a result, the business owes the lender $4,760 in fees, plus the original $64,000 received upfront.

In total the business retains $75,240 of the original $80,000 of outstanding invoices.

So, which is better? Invoice factoring or invoice finance?

Choosing which option is better depends on the nature of your business, the number of clients you invoice, the size of your business and length of operation.

The pros and cons of invoice financing:

Pros

• Invoice financing can be a great option if your business is still small, or has only been operating for a couple of years.
• Ideal option for businesses with only a small number of clients.
• Small to medium sized businesses can get access to invoice finance without a long-term commitment, or involuntary tie-up. Whereas invoice factoring usually demands a contractual tie-up between your business and the factoring company.
• Invoice financing does not require any collateral besides unpaid invoices, making it a more viable option than a traditional bank loan.
• It is a great option for businesses that have repeat customers with significant transactions.
• Your business relationships with your clients remains confidential, as the invoice management remains with you.
• Invoice finance is a simple, stress-free process.

Cons

• The downside of payment collection remaining internally can be added stress on staff and added costs in terms of invoice management.
• It can be expensive, dependent on the lender’s fees.
• If customers don’t pay on time, you will be required to pay additional fees to the lender.

The pros and cons of invoice factoring:

Pros

• The business receives the bulk of the invoice totals upfront. This means improved and predictable cashflow.
• In most cases, invoice factoring is easier to obtain and is cheaper than a traditional business loan, making it an ideal short term funding option.
• Debt management is taken out of the business, freeing up the accounts and administration personal.

Cons

• Invoice factoring is not a suitable option for businesses with only a handful of large clients. Factoring companies who buy your invoices, to a certain extent, undertake the risk of some debtors not paying. Due to this they like to spread their risk over more customers, as it lowers the concentration.
• The factoring companies’ communication with your customers may cause internal friction.
• If invoices date back over a long period, more time and therefore more fees may be needed before all invoices have been paid.
• If the invoices prove hard to collect, or a customer fails to pay, a business may have to repay the amount given upfront, unless it pays extra for non-recourse factoring.
• Factoring companies assess the risks of customers. If your customers appear to be a credit risk, their fees will be higher.

After considering the pros and cons of each, if invoice finance feels like the right solution for your business, contact Grow Finance today. At Grow we offer straight forward invoice finance solutions for small to medium businesses, designed to provide flexibility and offer guaranteed cashflow solutions.

To find out more, talk to the Grow Finance team today, call 1300 001 420, or if you are ready to move forward, apply now.