Invoice Factoring vs. Invoice Financing: How Do They Differ?

Unpaid invoices can be a burden on any business. While you know that the money from the invoices will eventually come, slow-paying customers or extended repayment terms could hurt your incoming cash flow — and this could be a problem for your business.

Instead of waiting for weeks (or months) to get the money from the invoices,  how can you get the funding your business needs right away? What if you could get your unpaid invoices to work for you? What if you could sell your outstanding invoices or use them as collateral to get the money you need to cover an emergency or use it as working capital?

Suppose outstanding invoices create cash flow issues for your business. In that case, there are lending options available for you, like invoice financing and invoice factoring. They sound the same, but they’re very different.

What is Invoice Financing?

Suppose that your business offers extended credit terms to customers (between 30 and 90 days). In that case, the invoice financing allows you to use your invoices as a financial proof of payment to the lender in advance. Usually, you can get up to 85 percent of your invoice from the lender first, and then, once your customer pays the invoice, you’ll pay the lender back. 

What is Invoice Factoring?

Invoice factoring is related to invoice financing in that you still receive up to 85 percent of the invoice in advance from the lender. However, unlike the invoice financing, this actually involves selling your invoices to a third party. Factoring companies will get the full amount of the invoice from the customer on your behalf.

Keep in mind the following differences between the factoring of invoices and the financing of invoices:

Flexibility

Invoice factoring may require you to support most or all invoices at the maximum possible rate of funding. On the other hand, the financing of invoices allows you to choose which particular invoices and even which customers you want to finance.

On-demand vs. Ongoing Financing

As invoice factoring may require you to finance your entire sales, you should think of it as a credit line linked to your account receivables. This means that you have access to an ongoing source of funding. However, invoice financing allows you to choose which invoices to finance and when giving you on-demand funding. Keep in mind that many lenders offering invoice financing also offer business lines of credit.

Collection of Debt

Invoice financing may or may not provide debt collection services. However, companies using invoice financing are more likely to have credit and debt management services, which means that they will not need these services. In opposition, invoice factoring companies almost always come with debt management services.

Confidentiality

Invoice financing may allow confidentiality as far as your customers knowing or not knowing whether you’re using a financing company to collect invoice payments. However, invoice factoring usually means that your customers are notified that their invoices will be managed and collected by a third party.

Which One is Right for My Business?

Due to flexibility and credit management services, the financing of invoices is popular among smaller firms. At the same time, invoice factoring is usually better suited for larger companies with in-house collection services.

Finally, however, it comes down to your particular situation. You can ask yourself the following three questions to help you decide what’s best for your business:

What Do I Need the Funds For?

If you need an ongoing financing source because your business is expanding quickly, invoice factoring may be the right option for you because you can save by committing to a long-term contract. But if you’re stuck for cash only on occasion, such as when trying to make payroll or when dealing with seasonal downtimes, invoice financing may be better suited to you because you can choose how many invoices to finance and when.