Key takeaways
- Invoice financing and invoice factoring are best for business-to-business (B2B) companies struggling with unpaid invoices.
- With invoice financing, the business owner works to collect payment from the customer. With invoice factoring, the factoring company takes over payment collection.
- Both options include you paying a fee to the lender and often double-digit APRs.
Small businesses that need to manage cash flow issues or cover short-term expenses might consider using invoice financing or invoice factoring. Both of these types of financing allow you to use your unpaid invoices to access capital for your business.
Although invoice financing and factoring are often confused for one another, the two products differ in structure and repayment process. Here’s everything you need to know.
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Invoice financing vs. factoring, summarized
| Differences | Invoice financing | Invoice factoring |
|---|---|---|
| Also known as | Invoice discounting, accounts receivable financing. | Debt factoring, accounts receivable factoring. |
| Financing structure | Loan or line of credit backed by your outstanding receivables. | Factoring company purchases your outstanding invoices at a discount and advances you a portion upfront. |
| Collections process | You collect repayment from your customers. | The factoring company collects repayment from your customers. |
What is invoice financing?
Invoice financing refers to borrowing money against your outstanding accounts receivables. A lender gives you a portion of your unpaid invoices upfront, sometimes as much as 90%, in the form of a loan or line of credit.
Once your client pays the invoice, you pay the lender back the amount loaned plus fees and interest. Your business is still responsible for collecting outstanding money owed by your clients.
Invoice financing example
Let's say you’re going to finance a $50,000 invoice with 30-day terms. You finance the invoice with a lender and receive 80%, or $40,000, upfront.
The lender charges a 3% fee for every month the invoice is outstanding. Your customer pays within the month, so you keep $8,500 and repay the lender $41,500 — the original $40,000, plus an additional $1,500 in fees.
In total, you received 97% of the invoice value — $48,500 out of $50,000 — and the invoice financing company received $1,500 in fees. This calculates to an annual percentage rate of 45%.
What is invoice factoring?
With invoice factoring, you sell your outstanding invoices to a factoring company at a discount. The company pays you a part of the invoice amount upfront and then takes responsibility for collecting the full amount. Once the company collects the full repayment from your customer, they send you the difference, minus the agreed-upon fees.
» MORE: Best factoring companies
Invoice factoring example
Let’s say you’ve sent a $50,000 invoice to a customer with 30-day repayment terms. You need the money soon, so you contact an invoice factoring company. The company purchases the invoice and sends you 85% of the value upfront, $42,500.
The factoring company charges a 1% fee for every week it takes your customer to repay the invoice. Your customer pays the company after four weeks. The company deducts its fee of 4% — $2,000 — and sends you the remaining balance of $5,500.
In total, you received 96% of the invoice value, $48,000 of the original $50,000, and the factoring company received $2,000 in fees. This calculates to an approximate APR of 56.47%.
Pros and Cons of invoice factoring and financing
Pros
Ideal for B2B businesses that have cash flow issues due to unpaid invoices.
Can be easier to qualify for than other business loans, even if you’re a startup owner or have bad credit.
Cons
Fees often amount to a high APR, making these options more expensive than some other business loans.
Relies on customer payments, which makes it difficult to estimate the cost of financing upfront.
Invoice financing vs. factoring: Which is right for my business?
Invoice factoring is a good option for businesses that don’t mind allowing the factoring company to take over payment collection. It can be particularly useful for smaller businesses that don’t have resources to devote to following up on invoices.
If you’re a new business or have bad credit, factoring may be easier to qualify for as it relies more on the credit profiles of your customers. But it may also have higher fees.
Invoice financing is a better option for businesses that want to keep control over their accounts receivable. It makes sense if you have a strong relationship with your customers and can collect quickly on your outstanding invoices.
Dive deeper
- To learn more about invoice financing, check out our articles on accounts receivable financing and invoice discounting.
- To learn more about invoice factoring, check out our articles on accounts receivable factoring and debt factoring.
This article originally appeared on Fundera, a subsidiary of NerdWallet.
Sarita Harbour contributed to this article.
