Invoice financing vs factoring: What’s the difference?
Many small business owners new to invoice funding wonder what the difference is between invoice financing vs factoring. They are decidedly not interchangeable terms. It’s important to know the difference so that you can choose the best option for your company and your current situation. By the end of this post you’ll have most of the info you need to do just that. (You can even use both options at the same time for different reasons, but we’ll get to that later.)
Without further ado, let’s get into the definitions.
Invoice Factoring Definition
Invoice factoring is a financial tool where a business owner sells invoices to a factoring company. The business owner receives cash for the invoice amount, less fees, ahead of the payment terms. The business owner’s customer, who is responsible for paying the invoice, instead pays the invoice amount to the factoring company according to the original payment terms. (See our post on the definition of factoring if you want to explore this more.)
Invoice Financing Definition
Invoice financing is a financial tool where a factoring company gives business owners cash for their invoices, and the business owner repays the factoring company themselves. The terms include an agreed-upon repayment schedule, with a fee spread out across the payments. The business owner’s customer pays the business owner according to the established payment terms.
So What's the Difference Between Invoice Financing vs Factoring?
Understanding the definitions is just the first step to choosing the right invoice funding option. Like many things, the true differences are in the details.
For both factoring and financing, you receive cash for your invoice way ahead of the typical 30 to 120 day payment terms. As you’ll see, some of the differences are obvious and some less so:
- Fee schedules. With factoring, the fee is withheld from the advance before it lands in your bank account. With financing, a portion of the fee is added on to each payment.
- Invoice totals. Oftentimes, large invoices are recommended for factoring, small invoices are recommended for financing.
- Repayment plans. The business owner’s customer redirects payment to the factoring company when an invoice is factored. The customer pays the business owner directly for a financed invoice. (In both cases the customer is only obligated to pay according to the invoice payment terms; it’s who they are paying that is different.)
- Parties involved. With factoring, the business’ customer is involved because they have to redirect payment. With financing, the customer isn’t involved.
- Mental burden. When business owners finance invoices, they have to make sure cash is available wherever a payment is due to the factoring company. When they factor invoices, they don’t have to keep an eye on their bank account because the fee has already been withheld from the advance. Additionally, the factoring company handles the account receivable.
On that last point, that’s not to say that you shouldn’t finance invoices; in many cases it’s the right choice. Monitoring your bank balance is simply a consideration to be aware of.
Before going any further, looking at why business owners fund invoices at all will give you more context when weighing your options.
Why Do Business Owners Fund Invoices?
On the surface, it seems obvious: customers demand invoices with long payment terms, creating a delay for business owners who need cash – not another account receivable. This happens in businesses of all sizes and across industries, but it’s especially tough on small businesses. Lower, less established cash flow makes it harder to ensure there’s enough coming into their business bank account to compensate for what’s going out – and that’s not even taking into account cash needed to grow.
Simply put, invoice funding can certainly help business owners make payroll, pay suppliers, and handle an emergency. But it can also be used to fulfill large orders or projects from well-known customers. Or ramp up production and service when you get a big break and the bookings are rolling in. It’s a fact that you need cash to grow your business. Funding invoices is one way to get it.
Getting back to why business owners fund invoices, those are all the logical reasons, but they’re not the only reasons. We’d be remiss if we didn’t mention how much stress business owners are under when they need better cash flow. Not only can it seem like a difficult problem to solve, it takes their attention away from the important work of serving their customers and growing their companies.
So which funding option is the right one? Chances are, the answer is both.
When to Use Invoice Factoring vs Invoice Financing
That’s the question we posed to our customers to get a clear understanding of how factoring and funding help them in different ways and in different situations. Seeing their responses in their own words will give you more insight into choosing a funding option along with ways you could use invoice factoring to grow.
I use invoice factoring when…
- “My business and invoices are growing”
- “I don’t want to worry about collections”
- “I don’t want to worry about having enough money in my account for repayments”
- “I’m able to push the price onto my buyers”
- “I’m invoicing cross border and don’t want to handle accepting payment internationally”
- “My invoices are large”
- “I want to feel comfortable to take on larger deals”
I use invoice financing when…
- “I need an alternative to wiring my own funds into the business from time to time”
- “I only need a small amount of money; it’s quick.”
- “My customer doesn’t accept factoring agreements”
- “My invoices are smaller”
A few themes come out here. Financing gives customers fast and flexible funding suited to smaller invoices. Factoring gives them more time back in their day and reduces complexity, and is suited to larger invoices.
If you’re still struggling with which option to take, dive deeper into the pros and cons of both factoring and financing. If you know which one you’re interested in, take the next step!