How Does Invoice Factoring Differ from Invoice Financing?

From time to time, most SMEs find themselves chasing unpaid invoices. But when long delays between raising invoices and collecting payments are the norm, a stopgap solution is needed to ‘bridge’ this financial void.

This is where invoice financing and invoice factoring can help. Two products designed specifically for this purpose, helping businesses maintain optimum cash flow at all times.

Is there any difference between the two, and which is likely to be the right choice for your company?

What is Invoice Financing?

Invoice financing provides businesses with the opportunity to access an affordable cash advance, based on the value of one or more outstanding invoices.

For example, a business with unpaid customer invoices totalling £10,000 could apply for £9,000 (at 90% LTV) with an invoice financing specialist. The outstanding invoices are used as security for the loan and the funds can be made accessible in as little as 24 hours. This money can then be used to keep the business moving until they receive payment from their customers.

At which point, the loan is repaid in full, complete with all agreed interest and borrowing costs. All fees and charges are agreed upon in advance, so the borrower knows exactly how much they will repay and when.

This can be an extremely useful facility for keeping important customers happy, and for building strong long-term relationships. Reliable customers (who just happen to pay a little further down the line) need not be chased down for payment and the business maintains good cash flow with an affordable funding solution.

What is Invoice Factoring?

Meanwhile, invoice factoring takes a slightly different approach to the same basic lending model.

Just like Invoice financing, invoice factoring allows the company to access 90% of the amount regarding outstanding invoices, this usually takes about a day to complete. Of course there are also rules set in place regarding the amount this can be borrowed, this money can be used for any legal purpose.

However, the difference with invoice factoring lies in how the facility is repaid.  When you apply for invoice factoring, you effectively sell the customer’s debt to the service provider. With invoice financing, you are responsible for collecting your payments from your customers and for repaying your loan. With invoice factoring, the provider directly chases up your customers for the money they owe, and collects it directly from them.

For this, a higher fee is payable, interest rates are typically slightly higher with invoice factoring. A more ‘hands-off’ approach than invoice financing, invoice factoring effectively transfers customers’ debts to an external service provider, for an agreed fee.

Which is Right For Your Business?

Choosing between the two comes largely down to whether or not you are concerned about the effect invoice factoring could have on your customer relationships.

In the case of loyal customers your business counts on, it would be inadvisable to have a third-party chase them down for outstanding payments. But in the case of one-off customers that are simply not complying with your requests for payment, transferring these debts to an external service provider could be a better option.

Most SMEs choose invoice financing as their preferred everyday solution, as it enables them to retain full control over the debt collection process. Their customers enjoy flexible repayment terms and good relationships are maintained. Invoice financing can also be the more cost-effective solution, meaning less of the value of the invoices you raise goes into the pockets of the provider.