Invoice factoring vs invoice finance: what's the difference?
Making sense of invoice factoring and invoice finance.
If slow paying customers are disrupting your cash flow you could use invoice factoring to get paid faster.
It’s been around for centuries.
But more recently, invoice finance joined the party.
Invoice finance, like factoring, gets you paid faster but instead of selling your invoices to a factoring company you borrow money against your invoice.
The difference sounds subtle but they have big consequences.
How does invoice factoring work?
With invoice factoring, you access the money from an unpaid invoice.
A factoring company buys your invoice and then they collect the money directly from your customers.
That sounds a lot like a credit stretch, how is it different again?
Well, the factoring company - after buying your invoices - approaches your customers to get payment from them.
With a credit stretch, you offer your customers 60 days of credit, for free. And if they want a little longer, an extra 30 days costs them just 1%.
A credit stretch will only improve your customers’ relationships, not harm them.
Also, many of our customers switched from factoring because they wanted to buy all of their invoices, not just the ones they needed now.
With a credit stretch, you use it when you want - as little or as often - you choose.
Factoring is a largely manual process. That means it’s quite slow. Decisions can take weeks.
But a credit stretch is fully automated, meaning a decision will take minutes, sometimes seconds, and you’ll have your money as soon as your customer signs the stretch.
Also, factoring can be out of reach for smaller SMEs. They’re simply not creditworthy enough.
A credit stretch doesn’t care about your creditworthiness, just that of your customers’. So, if they’re creditworthy - which they likely are - you’ll get finance from us.
Let’s get back to talking about invoice factoring - we’ll come back to the credit stretch later.
Invoice factoring is an alternative to loans
SMEs, instead of working with banks, can go to a factoring company to get their invoices paid faster.
You sell your invoices to the factoring company in return for money you can use to grow your business.
But beware of the consequences of selling your invoices.
What happens when I sell my invoices?
Now we know that a factoring company buys your invoices. They’ll usually pay 60%-90% of the invoice amount.
Woh! Why only 60%?
Because they’re taking a risk by lending you the money. They’ve still got to collect from your customers.
Let’s find out more about that.
Once you’ve sold your invoices to a factoring company, they now own it. Which means they own the process of getting paid from YOUR customers.
A factoring company is part financing company, part debt collecting company.
They will contact your clients. Now your clients will pay the factoring company directly.
It’s crucial that you consider the implications of handing your important customer relationships over to a third party to collect money. This is where many SME owners get the jitters.
But if you’re okay with that, then let’s continue.
Invoice factoring lets you offer longer payment terms
Which in many industries is a competitive advantage.
If you’re offering longer payment terms to your competitors, you’re helping your clients grow themselves. And it won’t cost them anything.
But doing that will harm your own growth because you won’t have the funds available to invest in your own company.
If you’re comfortable with the factoring company collecting the money from your customers, you can use factoring to give yourself a competitive advantage and allow your customers to use their longer payment window to invest in their own growth.
How you can use invoice factoring to increase cash flow
Invoice factoring for speeding up payments has been around for close to 1000 years. Here are some of its major uses:
- “Making Payroll”
- “Staffing and Hiring”
- “Investing in growth”
- “Paying Rent and mortgages”
- “Getting paid faster”
- “Buying More Inventory To Increase Margin”
- “Buying Materials For Projects”
- “Buying New Equipment”w
That just about covers invoice factoring. Let’s move on to invoice finance.
What is invoice finance?
Invoice factoring and invoice finance are often used interchangeably. But they are not the same thing.
As we’ve established, invoice factoring companies require you sell your invoices to them.
With invoice finance, you’ll get a line of credit based on your invoice amounts that your clients won’t know about.
So you can control your cash flow AND your customer relationships AND get paid faster.
So yeah, it is kind of like factoring, but probably quite a bit easier and less embarrassing.
Which option is right for you?
Invoice finance, like factoring, is an alternative to loans.
Loans are slow and the chances of getting one at a fair price is pretty low these days.
If you don’t want a credit stretch, your next best options are invoice finance and factoring.
But which one is right for you?
The pros of invoice finance
Online invoice finance services are pretty quick today. You could get finance within a few days - much faster than a loan.
You’ll then have 12 to 24 weeks to repay the debt.
It allows you to solve cash flow issues. And, unlike factoring, you’ll get the full invoice amount paid to you.
You’ll collect money from your customers directly and use that to pay back the finance company meaning you protect vital customer relationships.
The cons of invoice finance
Unlike a credit stretch, your creditworthiness really matters.
If you don’t meet the strict criteria set by the finance company, you’ll be rejected.
More modern invoice finance companies require that you use specific accounting software. If you use the software, the process will be fast. If you don’t, well, either change tool or look elsewhere.
If you are using the correct software the finance company will then look through your transaction history. If you’ve had any money problems that are present within your accounting software, you’ll probably get rejected.
Let’s take a dive into the pros and cons of invoice factoring.
The pros of invoice factoring
Because you don’t have to put up collateral, there’s a chance you could get accepted for factoring even if you have bad credit. Although it could affect the price you pay.
You’ll get money much faster than a loan. Although it could be slower than invoice finance and a lot slower than a credit stretch.
Finally, the part about them collecting payments from your customers. I’ll pitch this as a pro now but expect it to be a big con in the next section.
If a factoring company collects payment directly from the customers you won’t get distracted from growing your business by constantly chasing late payments.
Well, I tried! It could be a benefit to you.
Anyway, let’s move on.
The cons of invoice factoring
Factoring can be very expensive.
It’s going to take a chunk of your profits.
And it’s not just the fees, which are often higher than invoice finance and much higher than a credit stretch. Expect service fees, monthly maintenance fees, credit check fees, late payment fees, and many more hidden costs lurking in the darkness of your agreement.
Most factoring companies expect you to enter into a long term contract.
Our customer Freddy stopped using a factoring company because they wanted to buy all of his invoices off of him. For most SMEs, this is borderline suicide. Especially if the fees and rates are eating into your profit for growth.
If you’re in a long term contract, it’s likely that the factoring company could stop you from working with certain customers they deem unlikely to pay their balance.
WHAT??? Why and how can they do that???!
Well, once you sell your invoices to a factoring company, your customers also become their customers. Factoring is like starting a partnership where you do the work and they collect your debts. If they feel that your client is going to not pay or be too difficult to chase they may stop you from working with them.
Lastly, factoring companies collect payments directly from your customers. This could be embarrassing - it signals to your customers that you’re having money trouble. It also disrupts the relationship between you and your customers. Relationships that may have taken years to build and nurture.
The credit stretch: a better alternative?
If you’re interested in invoice finance or factoring you may be interested in a credit stretch.
A credit stretch solves cash flow issues, too. And it also involves a third party who gives you access to the funds tied up in unpaid invoices.
But the credit stretch is faster, fairer and easier.
Instead of harming your customer relationships, like in factoring, or keeping them in dark, like with invoice finance, a credit stretch gives you something of great value to offer your customers - 60 days of interest free credit, which they can extend another 30 days for just 1%.
A credit stretch also eliminates the risk to you because each stretch is insured by our credit partner.1
You won’t need to leave the comfort of your office chair to get a credit stretch. You won’t even need to speak to anyone on the phone.
You can do it all in a matter of minutes through the CreditStretcher app.
You’ll get a decision not in weeks, days or even minutes, but immediately.
Most importantly, because the cost of production is so low, by way of automation, the price is lower than factoring and you’re much more likely to get approved because we’re only interested in the creditworthiness of your customer - a decision that is also made near instantaneously.
We believe that the future of invoice factoring and finance is the credit stretch.
If you want fast, easy and fair finance that gives your customers something of value, the credit stretch certainly is the better alternative.
Want to stretch your credit? Create an account with CreditStretcher today.