If you offer extended credit terms to customers, you may qualify for funding without the need for good credit or collateral.
If your business is in a cash flow squeeze and you don’t have the assets or the ability to get bank financing, you may want to consider two valuable sources of funding: debtor finance and invoice factoring.
Not only can these provide on-demand or ongoing sources of funding, they may also come with credit management services that can help you collect payments from customers. But what exactly is the difference between debtor finance and invoice factoring? In many ways they are very similar, yet they differ on some very important points.
What is debtor finance?
If your business offers extended credit terms to customers (between 30 and 60 days), debtor financing allows you to “sell” your invoices upfront at a discounted rate. This prevents you from having to wait to get your money, which is important if you need working capital. Instead of waiting to get paid, you can get up to 80% of your invoice upfront, and once your customer pays the invoice, you’ll receive the remaining 20%, minus fees.
What is invoice factoring?
Invoice factoring is a specific type of debtor finance that’s a bit different to other debtor finance facilities. The general idea is similar and you still receive up to 80% of the invoice upfront, while receiving the remaining 20%, less fees, once your customer pays.
However, in contrast to debtor financing, invoice factoring offers added flexibility in terms of which invoices you finance and when. Invoice factoring companies also provide debt management/collection services so you won’t need to chase after customers for payment.
What are the key differences?
Keep in mind the following differences when deciding between invoice factoring and debtor financing:
- Flexibility. Debtor financing may require you to finance most or all invoices at the maximum funding rate possible. This is usually 80%. On the other hand, invoice factoring lets you choose which particular invoices and even which customers you want to finance.
- On-demand vs ongoing funding. As debtor financing may require you to finance your entire sales ledger, you should think of it as a line of credit linked to your account receivables. This means you have access to an ongoing source of funding. However, invoice factoring allows you to select which invoices to finance and when, giving you on-demand funding.
- Debt collection/management services. Debtor financing may or may not offer debt collection services, although businesses using debtor financing are more likely to have credit/debt management departments, meaning they won’t need these services. In contrast, invoice factoring companies almost always come with debt management services.
- Confidentiality. Debtor financing may offer confidentiality as far as your customers knowing, or not knowing, whether you’re using a financing company to collect invoice payments. However, invoice factoring usually means your customers are notified that their invoices are going to be managed and collected by a third party.
Which one is right for my business?
Because of the flexibility and credit management services, invoice factoring is popular among smaller businesses. At the same time, debtor financing is usually better suited to larger companies that have in-house collection services. However, it always depends on your particular situation. You can ask yourself the following questions to help decide what’s best for your business:
- What do I need the funds for? If you need an ongoing source of financing because, for instance, your business is growing quickly, debtor finance may be the right option for you. But if you’re strapped for cash on occasion, such as when trying to make payroll or when dealing with seasonal down periods, invoice factoring may be better-suited to you since you’re able to choose how many invoices to finance and when.
- Do I need credit/debt management and collection services? Smaller businesses may want to take advantage of credit management services that invoice factoring companies offer while larger businesses may not need such a facility.
- How much can I afford to pay? One drawback of invoice factoring is cost. Since you’re financing single invoices (or single batches of invoices), setup and maintenance costs are increased. Moreover, the credit management services that come with invoice factoring are an added expense embedded into the discount rate (fee). Make sure you’re well aware of all costs associated with invoice factoring or any type of facility before you select that financing option.