Invoice factoring could be an efficient way to improve your cash flow, but do you know what type will best suit your business?
Keep in mind that there are several types of invoice factoring available, and it’s important to understand the differences between them.
First, what exactly is invoice factoring?
Invoice factoring is a type of business financing in which a business sells their outstanding invoices to a third party in exchange for a percentage of the amount due as a lump sum. This helps business owners sell their accounts receivables to meet immediate cash needs.
Is invoice factoring the same as invoice financing?
No. Invoice factoring differs from invoice financing in that factoring shifts the responsibility of collecting the amount due to the third party. After you sell your invoice, the third party will contact the customer receive the full amount of the invoice.
With invoice financing, you’re essentially getting an advance from a lender based on what you’ve invoiced your customers but you’re still responsible for collecting the amount due.
Compare invoice financing vs. invoice factoring
Three types of invoice factoring to compare
- Whole turnover
Sell all of your invoice to a third party for a specified time period.
- Selective invoice factoring
Sell only the invoices you choose over a specified time period.
- Spot factoring
Sell individual invoices with no quantity or timeframe commitment.
Whole turnover
This is a popular choice for companies that are expanding and want a long-term solution for their invoice factoring. Factoring companies will likely want to work with you on a 12-month basis and can offer low rates and fees in return.
Depending on the the quantity and consistency of your invoices, factoring companies may be able to provide your business with as much as 90% of what you invoice.
- Lower rates and fees than shorter term factoring arrangements.
- May provide additional credit and debt collection services.
- Less flexibility, invoices are typically financed in the order they’re received.
Selective invoice factoring
Selective invoice factoring allows for companies to account for a number of factors that can affect income — such as the time it takes individual customers to pay invoices, peaks in trading and unique agreements with specific customers.
This type of invoice factoring involves an ongoing relationship with your lender but gives you the option to choose which invoices you finance and when. These features makes this brand of factoring a sound option for small businesses who deal with a diverse array of clients and customers.
- A flexible format that allows a company to capitalize on profitable customers while leaving out invoices they expect to be paid quickly.
- Typically higher rates than those offered by whole turnover factoring and doesn’t allow for the same hands-off approach.
Spot factoring
If your company needs income quickly, possibly to cover a one-time payment or meet the monthly payroll, you might consider spot or single factoring. This is for when you’re looking to access the funds from one invoice or a single load as quickly as possible.
Keep in mind that the speed of this type of invoice factoring is reflected in the costs, which are the highest out of the three types. The short period makes this type of invoice factoring less profitable for the lender, who may charge you weekly or even monthly for just a few hours of work.
- This is one of the most secure, risk-free ways to get cash for your company in a short period of time.
- An application fee and service charge may apply, along with charges as high as 15% of the invoice, making spot factoring an expensive type of business financing.
Bottom line
The type of invoice factoring you choose will may depend on the size of your company, your relationship with customers and how heavily your business relies on invoices for cash flow. Invoice factoring can offer efficiency and value that other business lenders don’t. By choosing the one that best fits your business, you can improve your cash flow and keep your customers happy.