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Invoice Financing, Factoring and Invoice-Backed Line of Credit: What’s the Difference?

Diego Caicedo
at OmniBnk
Mar 14, 2018

If you have outstanding accounts receivable, it's important to know your options.

Invoice financing, factoring and invoice-backed lines of credit can all help businesses deal with a slow cash flow. Which option is right for your business?

There are a number of ways small business owners can deal with outstanding accounts receivables. Solutions like invoice financing, factoring, and invoice-backed lines of credit can all help businesses deal with a slow cash flow. It’s important to know the differences between each option before making a decision.

Invoice financing  

Invoice financing is when you borrow money against outstanding accounts receivable. In other words, it’s a temporary loan for an unpaid bill and the lender gives you the money you’re owed now. Your business is responsible for collecting your client’s payment, and then paying the lender back the money loaned along with fees and interest. Invoice financing is a good choice if you know your client will pay their outstanding invoices, but you still need money quickly.  

Invoice factoring

Factoring involves a lender purchasing your owed accounts receivables, and then the service takes responsibility for collecting payment from your clients. Once they’ve received the full payment, they’ll forward you the difference – minus a percentage of the cut for their services.  

Invoice factoring suits businesses that have outstanding accounts receivables within the 60 to 90-day range, according to Fundera. Be aware that you’ll be accepting considerably less money than what you’re owed, but you won’t have to deal with chasing down overdue invoices.

Invoice-backed line of credit

With this option, a bank extends a line of credit that your business can borrow against, based on whatever limit and payment frequency has been set. Your outstanding accounts receivable act as an asset, which can be used to secure the financing. Banks consider these invoices a great form of collateral as they’re a liquid asset – and you’ll convert them to cash soon enough.

To secure an invoice-backed line of credit, your receivables need to be high-quality. This means your company needs to have a good history of collecting, and your customers need to have good commercial credit ratings.

This option is best left to more established companies (minimum one year old) with an excellent credit history. You’ll pay interest on the borrowed money, but at lower rates. Once your accounts receivables have been paid, you’ll want to pay off this line of credit to stop accruing interest.

Advantages of these alternative financing options  

The primary benefit of any of these options is the ability to get a grasp on cash flow issues quickly. Businesses can use invoice financing to pay operational costs without having to wait for payments on outstanding accounts. Invoice financing can also be used to pay vendors or even pay off your own lines of credit – an important aspect of improving your business credit.

At times, this may also be the only option if your business is still growing and you are not able to receive other types of business credit. Lenders will look at your invoices as a form of collateral and good financial will, and major factors like financial health and credit will be less of an issue.

Any of these options can help your business secure cash when you need it, but invoice factoring is a guarantee that at least a partial amount of your outstanding accounts will be paid. Many business owners don’t have the luxury of time to go chasing down delinquent payments. If your business has numerous late paying accounts or unpaid invoices, this is an option that ensures you’ll get at least some of what you’re owed.

Keep in mind, invoice factoring also limits the risk of not receiving any payment at all. Once a factoring company has stepped in, it’s their responsibility to collect the payments from your late customers. You won’t have to pay off a credit line or take out a business loan to cover the difference of a lost invoice.

Unlocking cash flow

While these options can be a simple method for dealing with cash flow issues, they can also cost your business more in the long run if not used wisely. This is especially the case if your financing fees are reliant on when the client pays you back. Fees for invoice financing include a flat processing fee set by the lender – often 3 percent of the overall accounts receivable and then an additional percentage per week each invoice remains outstanding. Invoice factoring could also adversely affect your businesses reputation among customers, since it involves a middleman collector. Finally, it’s important to remember that credit always has to be paid back as well.

For growing businesses, there are plenty of ways to secure alternative forms of finance outside of the traditional routes. The alternative financing options mentioned above can help unlock your business cash flow; it’s just a matter of deciding which one best suits your needs.

Editor’s Note: Looking for information on factoring services? Fill out the below questionnaire to be connected with vendors that can help.

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Diego Caicedo
CEO of Portal Finance, a platform that evaluates electronic invoices from companies and leverages e-invoicing and open data in custom solutions for financial partners to fund SMEs.