With invoice factoring, the factoring company will take over the sales ledger and credit control of the customer, becoming responsible for chasing up the outstanding invoice. With invoice financing, the business is responsible themselves for chasing up the invoice from its buyer and paying back the loan to the finance provider.
In this article:
- What is invoice financing?
- What is invoice factoring?
- Advantages of invoice financing and factoring
- Disadvantages of invoice financing and factoring
What is invoice financing?
A business can raise cash by a process called invoice financing.
Invoice financing is where a finance provider will loan to the business up to 90% of an outstanding invoice.
The business supplier however is still responsible for chasing up the invoice from its buyer and paying back the loan to the finance provider.
It is the business supplier that sets up the arrangement with the finance provider and pays the fee for its service.
The buyer doesn’t need to be aware of the loan and pays the invoice as normal to its supplier on maturity.
What is invoice factoring?
A business can also raise money by a process called invoice factoring.
Invoice factoring is where the business sells its invoice to a factoring company. The factoring company will then let the business access a percentage of its value, which can be up to 90% - for a fee. The factoring company will take over the sales ledger and credit control of the customer and become responsible for chasing up the outstanding invoice.
Once the outstanding invoice has been paid, the business will receive the remaining percentage of the invoice value.
Invoice factoring is less risky for the lender as they have more control over the customer paying on time.
What are the advantages of invoice financing and factoring?
- It is an ideal way to raise finance for a business that has a high cost of sales or is seasonal in its operations
- It is quicker to arrange than a traditional business loan.
- It can be a less risky form of finance as it is based on the value of your sales ledger rather than a bank loan which may include risking personal assets.
- It is a form of financing that allows businesses to speed up access to money that it is owed from customers without having to wait for invoices to be paid. A benefit of this can be that any investment or growth decisions can be met earlier and any issues around cash flow shortage, in particular when managing ongoing business operations, can be avoided.
- A business can ensure it receives a steady flow of cash at the right time without needing to enter into long term committed contracts.
- It can allow a business to stay in control of its cash flow by only accessing funds when it needs to and allowing it to improve turnover and profits.
- It can be helpful in converting any sales made on credit into cash.
What are the disadvantages of invoice financing and factoring?
Invoice financing is generally only offered to businesses with commercial clients as they are less risky so may not be available for businesses that deal mainly with the general public.
Invoice factoring requires handing over details of customers to a factoring company. This may have an impact on a business's customer relations, the factoring company's main interest is in getting invoices paid not maintaining customer relations.
Any invoice disputes or non payment by customers will require the business to pay part if not all of the outstanding debt to the finance company.