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Given the current state of the economy, cash flow has likely become more of a pressing concern for every business. When loans and credit lines are no longer an option, companies turn to invoice discounting and factoring to alleviate cash flow problems and raise immediate funds. So, what’s the difference between these two options and how can they help businesses raise capital?
What is Factoring and How Does it Work?
Factoring is simply taking an outstanding balance owing on a customer’s invoice and selling it to a factoring company, which is simply a financing company. In return, these finance companies will provide the company cash for a portion of the invoice’s value, and then proceed to collect on that receivable. Once the receivable is paid in full, the company provides the difference back to the company, minus their fee for the transaction.
What Are the Different Types of Factoring Available?
Factoring is available in two options. There’s recourse factoring and non-recourse factoring. While there are benefits to both factoring options, companies must be sure they understand the differences between both.
- Recourse Factoring: In this option, the company selling the invoice is assuming all the risk and is guaranteeing the customer will eventually pay the finance company. If the customer doesn’t pay, the company is liable for the entire invoice amount.
- Non-Recourse Factoring: In this case, it’s the finance company that assumes all the risk, not the company selling the invoice. If the customer doesn’t pay, the company selling the invoice is not liable for that lost amount.
What Are the Fees and Costs of These Two Factoring Options?
Because the recourse option means the company assumes all the risk, the finance company tends to provide more upfront pay for the invoice and less of a fee once the transaction is complete. When the non-recourse option is taken, it’s the factoring company that assumes all the risk and therefore doesn’t provide as high an initial payout for the invoice, and might also charge a higher fee once the transaction is completed.
How Does Invoice Discounting Differ From Factoring?
Invoice discounting is a more discrete or secretive option for companies. Unlike factoring where the finance company pursues the company’s customers for payment, invoice discounting doesn’t involve the company’s customers in any way. In this case, the company uses its customer’s unpaid invoices as collateral or credit and draws cash from the invoice’s value directly from the finance company.
When companies use the invoice discounting option, they often receive a minimum of 70% to 80% of the invoice’s value. However, unlike factoring, the company must pay interest on the money they borrow and likely pays a monthly fee for the service. However, because it doesn’t directly involve customers, invoice discounting is sometimes the more preferred method.
When companies need to raise money, and can’t afford to wait for customers to finally get around to paying their bills, these two options are easy and faster than waiting on a business loan approval. Consider these as two simple and straighforward tools to resolve issues with cash shortages