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Editor's Note: Take a look at our featured best practice, Activity Based Costing (29-slide PowerPoint presentation). Activity Based Costing (ABC) analysis is a methodology for assigning costs to those activities that truly drive these costs. It is tangibly more accurate than traditional costing methods. Traditional costing methods overlook product-specific R&D, advertising, distribution/channel, and [read more]
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Invoice financing and factoring both provide great solutions for cash flow problems, but they do differ slightly in terms of structure and how payment is collected. So what are the differences and what’s the best option for your business?
What’s invoice financing?
Invoice financing allows businesses to access funding to help manage cash flow. Simply put, invoice financing involves borrowing money against your outstanding account receivables. In short, you will sell the invoice to a third party who will pay you up to 90% of the invoice in the form of a loan. This means that you can pay your staff on time, whilst waiting for your customers to pay their invoice. When the invoice is paid, this is transferred to the lender to pay for the loan.
Advantages of invoice financing:
However, there is a caveat. Whilst invoice financing is a good way to keep finances in check for many small businesses, it can be risky. As the lenders charge fees on the loan, if an invoice goes unpaid, it can land the business in a difficult position. If clients are avoiding the outstanding invoice, the costs can soon add up, and may end up costing the business more in the long run.
What’s invoice factoring?
Invoice factoring is where businesses sell their invoices to a factoring company (such as a bank) for some immediate cash release whilst waiting to be paid in full. From here, the bank will take on the responsibility for getting payment from your customers and will manage the invoice processing for the business.
Advantages of invoice factoring:
However, with this option the client will need to be aware of the factoring company, so you will need to trust that they will uphold the same standards of customer service as your own business.
Choosing the right option for your business
On the whole, invoice financing is riskier to small businesses compared to invoice factoring as the burden is on the business to chase invoices. With invoice financing, businesses can end up paying increased fees to the lender which can add up over time – especially if your clients tend to pay their invoices late.
Invoice factoring is often a good option for small businesses struggling with cash flow, and is less risky compared to financing, but you will need to choose your factoring company wisely. However, ultimately, the best invoicing solution depends on each individual. What’s best for one business may not be suitable for another.
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