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A Guide to Invoice Financing vs. Factoring

If your business is experiencing cash flow problems and a slew of late payments has left you with a lack of working capital, a short-term cash injection may be needed. So, do you apply for an emergency loan? Sell off some assets? How about drastically reducing your business overheads? There might be another solution. Invoice finance can help you recover the money you’re owed more quickly than would otherwise be possible. Explore invoice finance in greater depth – and learn more about invoice financing vs. factoring – with our definitive guide.

Invoice finance explained

Invoice finance refers to the variety of methods that businesses can use to release the cash locked in their accounts receivable. This can be a somewhat confusing topic, because while “invoice finance” is the term used to describe all the different ways that businesses can monetise their invoices, “invoice financing” refers to a specific type of invoice finance. Let’s explore the two main forms of invoice finance and give you a little more insight into which one is likely to best suit your business.

What is invoice financing?

Invoice financing, also known as invoice discounting, is a form of invoice finance wherein you borrow money against your company’s outstanding invoices. In short, a lender or discounting company will lend you a portion of the value of your accounts receivable (usually around 80-90%) in the form of a line of credit or loan. Then, when the client finally pays the invoice, you’ll repay the lender for the amount that they loaned you, plus fees and interest. With invoice financing, your company retains the responsibility of collecting the unpaid invoice from your customers.

What is invoice factoring?

You may also be interested in exploring invoice factoring, another type of invoice finance that requires you to sell control of your accounts receivable. Essentially, you’ll send the unpaid invoice to a factoring company, who’ll pay you the bulk of the invoice amount (around 80-90% once again) immediately. Then, once the customer settles the invoice, the factoring company pays you for the remainder of the invoice, minus their fee. Unlike invoice financing, invoice factoring places the responsibility of chasing up the outstanding invoices on the third-party financing company.

Invoice financing vs. factoring: what’s the difference?

There are more similarities between invoice financing and invoice factoring than there are differences. Put simply, both types of finance provide you with the opportunity to monetise your outstanding invoices for a small fee. It’s also worth noting that in both methods, the third-party financing company will usually want to take over most of your accounts receivable, rather than just a small batch of invoices. That can be a significant commitment and means that you probably can’t dip in and out of invoice factoring or financing whenever it suits you.

However, there are several differences that you should stay aware of. Firstly, and most importantly, there’s a major difference when it comes to who collects on the unpaid invoices. In invoice financing, the customer (you) will still be in control of your collections. On the other side of the equation, factoring an invoice requires you to sell it to a factoring company, which gives them full control over collections. In other words, you won’t own the invoice any longer or be responsible for collections, which is a radical deviation from traditional invoice financing.

Whether or not this is a good thing depends on the state that your company is in. While invoice factoring takes away the hassle of having to collect from late payers, you won’t be able to hide the fact that you’re using a factoring company. Customers may take this as an indication that your business is in trouble, which could potentially lead to a breakdown in the relationship. Although factoring companies will almost always be discrete and present themselves as part of your team, it’s still something to watch out for when you’re deciding whether to engage with invoice factoring.

Aside from the method of retrieving payment, as well as the confidentiality aspect, there are a couple of other differences you should know about when it comes to invoice financing vs. factoring. Cost is key. With invoice financing, you’ll normally only need to pay a 3-5% fee, meaning that your business will retain most of the invoice value. By contrast, invoice factoring has much higher fees attached, and in some cases, you could end up paying out as much as 15% of the total invoice amount (however, fees are much lower on a long-term contract). It’s also worth noting that invoice financing is more flexible and usually allows you to pick and choose the order in which invoices are financed.

Which one is right for my business?

Ultimately, the best invoice finance solution for your business comes down to your individual needs. Invoice factoring is often a better fit for larger corporations, whereas invoice financing is more suited to smaller companies. However, there are exceptions. If you need an ongoing source of financing, invoice factoring could be the right choice, regardless of the size of your business.

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GoCardless Ltd., Sutton Yard, 65 Goswell Road, London, EC1V 7EN, United Kingdom

GoCardless (company registration number 07495895) is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration number 597190, for the provision of payment services. GoCardless SAS (23-25 Avenue Mac-Mahon, Paris, 75017, France), an affiliate of GoCardless Ltd (company registration number 834 422 180, R.C.S. PARIS), is authorised by the ACPR (French Prudential Supervision and Resolution Authority), Bank Code (CIB) 17118, for the provision of payment services.