Running a business is not an easy thing to do. There are many factors that go into running a successful business. And many hurdles that need to be tackled. A hundred decisions need to be made every day and owing to the unique nature of each business and its customer base. There are no set formulae that a manager can follow to ensure that his company is a success.
Each decision made by a business-manager needs to be analyzed in a hundred different ways in a short time. In these circumstances, the best route would be to see each situation as a unique one and to consider each business decision carefully.
One of the most important decisions related to running a business is finance. How to get the necessary funds to run the business? And how to ensure that the kind of financing you choose does not affect the business negatively in the future?
In this article, you will learn about Invoice Based Financing and Invoice Factoring, two of the many ways you can obtain working capital for your business. After giving this a read, you can decide for yourself which kind of funding route you want to take for your business.
WHAT IS INVOICE FACTORING?
When a business sells its accounts receivables to a factoring company most businesses tend to run on a credit basis. Its customers do not pay upfront in exchange for any goods or services but pay after a set period. An invoice is a document that records this transaction, and when the customer pays later, this is referred to as the invoice being paid. Unfortunately, an invoice can not pay for new inventory, better equipment, or to hire new labor. Working capital is required for any business to continue to run and grow. Most companies tend to look for loans or other forms of finance to meet their cashflow requirements.
This is where invoice factoring comes into play. You can sell the invoices to certain companies that will then pay you a large chunk of the invoice’s value upfront, and a bit later when the customers pay the invoice. f
WHAT IS INVOICE FINANCING?
Invoice Financing is very similar to Invoice Factoring. When you go for invoice financing, you borrow money against your accounts receivables (instead of selling them like in invoice factoring). So unlike the money you receive for selling your accounts receivables, you are taking a loan or line of credit, and the accounts receivables serve as collateral.
The amount has gotten this way has to be returned to the lender along with interest and fee. Presumably when you collect the dues owed to you by your customers at the end of the month, or whatever period is agreed upon in the invoice.
WHAT ARE THE DIFFERENCES?
As has already been mentioned, Invoice Factoring is selling off your accounts receivables in exchange for working capital. This amount tends to be a large portion of the value of the accounts receivables, and the rest is returned after the money has been collected from the customers.
Invoice Financing is more of a loan taken against an asset. Invoice Financing is more similar to a conventional loan in that it is a line of credit that needs to be repaid along with an agreed-upon interest rate. Invoice factoring does not require you to return any amount afterwards since the factoring company keeps a cut of the amount recovered from the customer.
Another big difference is who collects the money from the customers. In invoice factoring, it is the factoring company’s job to do the collection job. In invoice financing, the task of recovering the amount owed is the duty of the business itself and not a third-party.
WHAT IS BETTER FOR YOU?
This is where invoice factoring gets a leg-up on invoice financing, if you go the factoring route, you will not be required to spend time in recovering the money from your customer. You can spend the resources that would be needed to run a billing department or to make a recovery in other activities. This frees up time and money to reinvest in your business to make it grow and prosper. While with invoice financing, you still have to invest valuable resources in getting your customers to pay back the money they owe you.
Another difference is that you get a larger chunk of the accounts receivables in the initial advance when doing invoice factoring. Typically, with invoice financing, you receive about 80% of the invoice value upfront. Relative to the almost 90% you receive when using a factoring company instead. Also, when using invoice factoring, you do not have to worry about any bad debts. Most companies have to account for customers that will default on their invoices and thus will lose money. That will become a worry for the factoring company instead. But you still will have to pay for your customer’s tardiness in payment with higher fees, however.
One area where it might benefit you to go for invoice financing is the cost of finance. You will be spending 1-2% with invoice financing and 2-4.5% on invoice factoring. Also, with invoice factoring, the rate charged will not be dependant on your history but your customers. This does take a little control out of your hand and into the customers. And depending on how diligent your customers are with paying up their invoices the rate you have to pay will go up and down.
While both invoice factoring and invoice financing are good ways to get working capital to ease your cashflows, there are some integral differences. Invoice factoring does give you a larger chunk of the accounts receivables, but the cost of investment is higher. Whereas with invoice factoring the fees is lower but so is the initial advance you receive. As a business owner, it is best to analyze your unique situation and to make the decision accordingly.