How Does Invoice Factoring Work and How is it Different from Bank Loans?

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Every business is unique – in the way, it handles customers, conducts daily operations, deals with unsightly scenarios, and the products they create. Just like every business is individual, every business scenario is also unique.

Although various factors can impact your decision on how to adequately finance your company to avoid going under, you need to consider two essential elements. How quickly you need the cash deposited into your business account and how much you are willing to pay for the loan services.

Regarding traditional bank loans, they may be more secure and reputable in today’s society. Since you need to prove collateral and equity, bank loans are only given to businesses that are trustworthy, established, and contain a good reputation. Along with confidence in the industry, banks need to see monetary gain and capital.

However, another option is invoice factoring. In this scenario, businesses do not need to provide background information to show a steady income stream or intelligent decisions. Instead, they need to fill out basic information to qualify for factoring in their finances.

What is invoice factoring?

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If you are a new business owner, you need to know what it is – since you may benefit from this process. Invoice factoring is a method of funding that provides your business with access to constant and immediate cash flow by selling your invoices to a third-party factoring company, such as factorfinders.com.

For example, if you know a client owes you $5,000 next month on a finished project, you may need that money now. Whether it be to pay employees, vendors, or other coworkers, needing the money on the spot can be hard to obtain – especially if the money is not due for another 30 to 60 days.

In this case, using this factoring can provide you with nearly the total amount in a matter of 3-5 days.

Invoice factoring steps

Before you choose it, you need to know how this process works. Although it can seem complicated for new business owners, the steps of invoice factoring are actually quite simple.

  • Step 1 – your business sells the invoices to another third-party company, like the one found on factorfinders.com, to pay invoices on the spot. Instead of waiting between 30 and 90 days for the client to pay their dues, you can collect cash immediately to increase your cash flow and get money in a few days.
  • Step 2 – you set up an account with an invoice factoring company. This account is where the owed money will be deposited into your account.
  • Step 3 – you submit outstanding invoices to the company. The outstanding invoices are projects from clients that have not yet been paid, meaning they owe you money that has not yet been received.
    • For example, if a business owes you $5,000 and it is not due until next month, the company can pay you between $3,500 and $4,500 on the spot. This keeps you from waiting for the client payment, and you will just have to pay back the total amount when the client pays you back within 30-90 days.
  • Step 4 – the company provides an immediate cash advance based on your invoice.
  • Step 5 – the debtor pays the invoice when they receive the payment from the client.
  • Step 6 – the amount is deposited into the reserve account.
  • Step 7 – The factor reduces the fees and pays you back the balance.

Invoice factoring example

Your business sells their service to Business A. You then issue an invoice to Business A of $2,000 days and give the company 60 days or less to fully pay the amount.

If you need money on the spot, you can sign an agreement with an invoice factoring company, like the one found on factorfinders.com. This agreement will either be a non-recourse factoring or recourse factoring agreement. You will typically have between a 70 and 90% advance rate of the services.

You can sell the invoice to the factoring company and receive an advance of between $1,500 and $1,800, depending on your client’s credit.

When the client is halfway through their pay period, around day 30, the factoring company will send a letter to the debtor that they owe money to your business.

Invoice factoring vs bank loans

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When you borrow from a bank, it is in a traditional form of credit or bank loan. When you borrow from an accredited financial institution with an approved credit line, you pay the principal and interest until the total amount is repaid in full to the bank.

Although these loans are the most traditional way to obtain money on the spot, they can quickly end up adding more and more debt to your already struggling business. For this reason, many companies turn towards it to get cash instead.

Pros of bank loans

  • The interest rates depend on the bank and type of borrowing – if you have good standing with your bank and high credit, you may find the interest rate is lower than invoice factoring.
  • You may be able to borrow more money if you have an established credit history.

Pros of invoice factoring

  • The approval process only takes a few days, meaning you can pay your clients within a business week.
  • No collateral is required to obtain the money for your business.
  • The interest rate is typically lower than that of bank loans – especially if you do not have a favourable credit rating or bank history.
  • Only your client’s credit history is assessed, meaning the business will not look at your company’s credit history (it can be the best option if your credit history is poor or fair).
  • No debt is incurred with advances, meaning that you do not accrue more debt over time as you would with a bank loan.
  • You have the financial flexibility and access to cash flow almost immediately to pay vendors and employees.
  • You can benefit from additional services provided by your invoice factoring business.

The three main reasons to choose invoice factoring instead of bank loans

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Although a bank loan can be more secure if you have a good line of credit, there are three main reasons why using it is better for your business.

Invoice factoring generates quicker cash in hand.

If you need cash immediately to pay vendors or clients, it can provide you with a cash flow in just a few days – compared to possibly months with a bank loan. When you finance through a hank, you can wait upwards of 90 days – just to get approved for funding, not even to get the cash in your account.

If your client has to wait 3 months to get paid, they will be extremely unhappy and can leave your business – along with writing poor reviews online about your company. Without fast funding for your company’s daily operations, like overhead expenses, daily payments, and employee wages, you can end up with no business at all.

With invoice factoring, your business can receive cash in hand or in your account in less than one day after you are approved. Your business can work directly with an invoice factoring company, like one found on factorfinders.com, to get between a 70 and 90% cash advance on invoice assets.

This company can approve your outstanding invoices based on the reputation and credibility of your customers, ensuring your business has a high chance of funding from an invoice company. You can get paid without waiting 30-90 days for the invoice to be submitted by the client by selling your factors.

You can manage your credit.

Even though you’re in debt, this doesn’t mean your credit score and credit history have to suffer. To get started as a successful company, you probably had to go into debt at some point – this is normal, and an invoicing company can help you out of the hole.

Using an invoice factoring business, like one found on factorfinders.com, you can secure more capital, constant cash and manage your debt until your credit score rises to the ‘Good’ level once more.

Avoid incurring excess debt.

Similar to managing your credit, it helps you avoid accruing excess debt by having to pay hefty bank loan interest rates or taking out personal loans. Non-recourse invoice factoring is an excellent way to stay afloat by avoiding paying out of pocket for client non-payments.

If your client doesn’t pay, you are not the one who has to put up the funds. Instead, the invoice factoring business will bite the bullet and pay for you – ensuring you don’t go deeper into debt.

Although this has high-interest rates for the future, this method lets you get a huge cash advance on the spot without having to worry about paying those funds to the company for non-payment.

Conclusion

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Using invoice factoring for your business can help with non-payments. These clients take long periods to pay outstanding debts and obtain constant cash flow to consistently pay vendors and employees. By having a steady influx of capital to power your company, you can acquire new clients and build a strong reputation in your field.

When comparing invoice factoring to bank loans, both have positives and negatives – but it provides quicker cash, lower interest, and potential benefits for clients.

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