As businesses grow, the quest for expansion also increases. Expansions require capital and even though some businesses have made enough to fund their expansions, other companies need to rely on external funding to expand. Sometimes, businesses do not only need extra cash to expand their businesses. In some cases, that extra cash is required to pay the staff, market the company, purchase an equipment, train staff, or even maintain a regular cash flow.
Fortunately, there are several lending options for small businesses. There are term loans, equipment financing, invoice financing, a business line of credit, and invoice factoring. If you have your businesses cash locked away in an unpaid invoice, you can opt for invoice factoring. Factoring your invoices will make that cash available to you even before your customers pay their invoices.
In technical terms, invoice factoring is not a loan. It is a method of getting an advance on your unpaid invoices. Invoice factoring companies will take your outstanding invoices and offer a lump sum in exchange. The lump sum is usually a percentage of the invoice amount. This percentage ranges from 80% to 95% in most cases.
Recourse and Non-Recourse Factoring?
When it comes to the risk-bearing aspect of invoice factoring, there are two options. There is the recourse factoring in which you as a business will take responsibility for the invoices your customers did not pay for. If your customers whose invoices you have factored do not pay up, the factoring company will return those invoices to you. You will need to offer a new invoice that is equivalent to or higher than the previous invoice amount.
With the non-recourse factoring, you will sell the invoices to the factoring company. The factoring company will assume responsibility for all the invoices. If a customer does not pay an invoice, the factoring company will take responsibility. Non-recourse invoice factoring is more expensive compared to the recourse factoring because the factoring company bears the risk.
Differences between Invoice Factoring and Bank Loans?
- With invoice factoring, the lender does not decide the amount you can receive. It usually depends on your invoice receivables. When your receivables grow, your limit also increases. Although factoring companies have a maximum amount they factor, the limits are usually high. With bank loans, the lender decides how much to offer you. Lenders look at your creditworthiness and decide the loan amount to offer you.
- Since invoice factoring is not a loan, you do not assume any debt. When your customers pay their invoices, the advance you received will be automatically cleared. Bank loans, on the other hand, attract interest that you will need to pay along with the principal. The terms of the loan will tell you how long you will repay the loan and the total amount you will be paying.
- Any form of business funding requires that the company offering the funds runs a couple of checks on the borrower. This has made it difficult for some small businesses to access financial support for their businesses. This is because most lenders request that your business should be of strong financial standing to access extra funding. Invoice factoring is flexible and different in this aspect. Even if your business does not a good financial standing, you can still qualify for invoice factoring. Factoring companies focus on the financial status of your customers rather than that of your business. This is because it is your customers who will need to the invoice, not you. When you get a bank loan, on the other hand, you will need to prove that your business is creditworthy. The lenders will check your annual tax returns, annual revenue, credit history, and your company’s assets and liabilities. Some lenders even check your personal credit score.
- One advantage with invoice factoring is the speed of funding. The initial application and funding process takes less than 7 days. After the initial process, subsequent factoring requests can be funded in less than 24 hours. Application for bank loans can take a few weeks. The lender will need to conduct several checks and the application in itself is also not simple. However, once the loan is approved, the lender will pay the cash into your account.
- With invoice factoring, the factoring company can adjust your rate when the invoices you are factoring increases. However, with the bank loan, the annual percentage rate for the loan term remains the same for fixed rates. For variable rates, the rate will depend on certain conditions mentioned by the lender.
Although invoice factoring is a fast method of business funding, it is more expensive compared to bank loans. However, your choice will depend on the situation at hand. If you need fast cash and you have unpaid invoices, you can opt for invoice factoring. However, if you are of good financial standing and do not need the cash urgently, you can opt for the bank loan.