When you own a small business, cash flow is always a concern. How can you pay your bills and employees when you haven’t yet been paid for your services? Fortunately, some financial organizations offer solutions to these issues. Two of these solutions are invoice discounting and invoice factoring. To determine which option is right for you, learn the differences here.
Also referred to as accounts receivable financing, invoice discounting allows you to borrow money up to a specific percentage of your outstanding invoices.
For example, a lender may let you take out a loan on up to 90% of the invoices you’re waiting for your customers to pay. So, if you have $100,000 in outstanding invoices, a lender may allow you to take out a loan of up to $90,000. Of course, the approval of this loan is dependent on your credit status and other considerations, and 90% is on the high end of the percentages loaned.
Once your customer pays their invoice, you pay back your loan with interest and fees. You are still responsible for collecting payment from your customers. Still, in some cases, a lender can directly connect to your accounts receivable system and deduct the amount owed to them once your customers pay.
The terms on invoice discounting loans are typically short, around 30 to 90 days, and are designed to simply get a small business through a cash flow rough patch.
Often referred to as accounts receivable factoring, invoice factoring is a process in which you sell your outstanding invoices to a company at a discount. The company pays you a percentage of the invoice amounts and becomes responsible for collecting the balance from your customers.
After they collect the full amount of the invoices from your customers, they pay you the remaining amount minus their fees.
For example, you have an outstanding invoice of $100,000 that you sell to a factoring company. They agree to give you 90% of the outstanding amount, so you receive an advance payment of $90,000 upfront. The balance owing is held as a reserve until the invoice is paid in full.
The factoring company then works to collect the full $100,000. When the factoring company receives the full invoice payment, they release the reserve amount and transfer the remaining $10,000 to your company. The factoring fee is taken from either the advance or the reserve.
Which Option Is Right For You?
Invoice discounting is better for companies with time and can collect outstanding balances from their customers. They don’t have to give up control of their invoices or collection methods and can still get the money they need for short-term expenses.
Invoice factoring is ideal for businesses that have trouble collecting outstanding balances from customers and don’t mind giving up that control. It is particularly useful for companies that don’t have the resources to follow up on unpaid invoices.
Both invoice discounting and factoring can help your small business through difficult cash flow times. Whether you want to use discounting or factoring really just depends on how you want your invoices handled, but the good news is there are solutions to your cash flow problems.