August 16, 2023
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Invoice Financing Should Not be a Loan
There are many different forms of financing, and one form you can use is invoice financing. With invoice financing you are basically getting funded for your receivables before they are due, speeding up your cash flow by 30 days or more. However, while the term financing is oftentimes associated with getting a loan or receiving an advance, with invoice financing it doesn’t need to be. While there are plenty of companies out there who will give loans and advances on your invoices, with accounts receivable factoring you are actually selling your invoices to a factoring company. Let’s take a look at what an advance is and how factoring compares to invoice financing.
What is an Advance?
When you offer a customer net 30 day payment terms you are giving them 30 days to pay for the merchandise you sent them. However, having your money tied up for 30 days in receivables means you have less access to working capital. So what many companies will do is they will borrow against the open receivables by providing an advance. In this scenario, a third party is paying you for the open receivable minus a discount. That third party will hopefully get paid back when your customer pays them for the invoice that they provided an advance on, but if your customer does not pay them back in a specified amount of time, then you will be required to pay them back. Additionally, since the advance is only for 30 days, you may have to pay interest if it takes longer than 30 days for your customer to pay.
How is Factoring Different from an Advance?
With accounts receivable factoring you are still converting your invoices into cash and getting access to working capital 30 days early, however factoring should not be an advance as you are not borrowing money against your receivables. In fact, factoring can be looked at like you are making a sale so long as it is non-recourse factoring. With non-recourse factoring you are actually selling the invoice to your factoring company. Your factoring company isn’t advancing you money, but rather purchasing a “product” from you, in this case that product is an invoice. What non-recourse means is that the invoice is fully insured against non-payment for financial reasons, so if your customer goes bankrupt or out-of-business, your factoring company is out the money, you are under no obligation to pay them back. So with non-recourse factoring you eliminate the need to have additional credit insurance.
In What Other Ways Does Factoring Differ from Invoice Financing?
Besides being a debt-free form of financing, factoring differs from invoice financing in other ways as well. First of all, with factoring, credit decisions are based on the financial strength of your customers as they are ultimately the ones responsible for repaying the factoring company. With invoice financing, certainly the financial strength of your customers is important. However, since you are the one who is ultimately responsible for repaying an invoice financing company if the customer doesn’t pay, your credit is also taken into account with invoice financing. As a result, a factoring company will perform credit checks on all your customers for you as they are the ones assuming the risk if a customer doesn’t pay. An invoice financing company may perform credit checks on your customer, but is probably more concerned with your financial strength than theirs.
With factoring, the amount of funding you can receive is only limited by your sales volume. While a factoring company will assign credit limits to each of your customers based on their credit, no credit limit is assigned to you, so as your business grows, the amount of funding you can receive grows as well. However, with invoice financing, since you are ultimately the one responsible for paying back the funds you receive, a credit limit is assigned to you and you are limited as to how much funding you can receive. Therefore, for a growing business, invoice financing may not be able to support their needs in the long term.
The last major difference is in collections. With factoring, your factoring company will handle all of the collection work. While this might not seem too important if you are already used to making these phone calls, it actually has more benefits than just saving you some time. Factoring companies work with many different vendors, and no doubt some of them will share the same customer base with you. So if a customer decides that they no longer want to carry your product, they may take their time in paying you, or maybe not even pay you at all. However, if they don’t pay a factoring company in a prompt manner, they could be cut off from several other suppliers as a result. Furthermore, factoring companies contribute data to credit reporting agencies, so a failure to pay a factoring company when an invoice is due will show negatively on their credit reports and could prevent them from being able to get net payment terms in the future. With invoice financing, you are still responsible for handling all of the collections yourself and don’t get to benefit from the leverage that factoring companies have over your customers.
Why do Some Factoring Companies Offer an Advance?
There are some factoring companies that do offer “advances”, however in this scenario they are more of a hybrid between factoring and invoice financing. The difference between these factoring companies and companies that offer invoice financing is that these factoring companies will provide you with a few additional services that factoring provides. Most likely they will perform credit checks on your customers, and they also will handle collections for you. However, they will charge you additional interest if a customer takes longer than 30 days to pay, so they may not put much effort into their collections until an account becomes seriously past due. It is also possible that they could be non-recourse, eliminating the need for additional credit insurance. So technically factoring companies that offer an “advance” aren’t giving you a loan, they are purchasing your invoices. However, they are purchasing your invoices for a smaller base fee, and then are charging you an additional fee for the optional advance, so you only get the benefit of improved cash flow if you agree to get charged an additional fee. While it is quite common for the larger factoring companies to offer an “advance”, there are also many smaller factoring companies out there who just pay you for your invoices the same day you invoice your customers.
The benefit of working with a company that just automatically pays you for your invoices is not only that you don’t need to request an advance, but that there is no additional fee for the benefit of improved cash flow. Some factoring companies even offer a flat rate for factoring your invoices, meaning you pay a fixed percent to factor any invoice, regardless of how long it takes your customers to pay your factoring company. Besides knowing exactly how much you will pay and being to build it into your prices, flat rate factoring has another benefit to it as well. Since your factoring company doesn’t make additional money from an invoice getting unpaid for longer, they have more motivation to collect on your invoices in a timely fashion, meaning your customers are less likely to be past due. If your customers aren’t past due, then they will be approved for reorders and you will be able to sell more to them.
How Do I Start Factoring?
It's very simple to start factoring. At DSA Factors we have a very simple two-page application that can even be filled out online. After getting everything filled out, we can usually start funding you in as little as 24-48 hours. We fund you for your invoices the same day you ship to your customers, no need to pay extra for an advance. We offer a flat rate fee structure so you know exactly how much you are going to pay. We also offer non-recourse factoring to all of our wholesale clients. If you have any questions, please feel free to give us a call at 773-248-9000, email us at info@dsafactors.com, or chat with us right here on this web page.
