If you’ve found yourself wondering what the difference is between invoice factoring and bank lending, you’re not alone. When researching the best way to finance your business, the number of options can be overwhelming.
While every business’s needs are different, invoice factoring does have some unique advantages over traditional bank loans. Let’s take a close look at these two popular financing options, how they operate and which of the two could be the better option for your company.
Bank loans are a well-known way of financing a business. Once you’ve applied for the loan and gone through the approval process (which typically takes a few weeks), you’ll have access to a finite amount of capital that you agree to pay back in addition to interest compounded on top.
One drawback is that loans don’t evolve with your business — they’re typically a one-time deal, the terms of which are difficult to adjust should your business needs change.
While conventional bank loans are popular due to their reasonably straightforward terms, they add more debt to your business. With interest, those loans can grow into a much more significant financial burden over time, especially if your business goes through a slow period.
Bank loans may not be the best choice for younger businesses. Even after you’ve been approved for the loan, you may not end up being approved for the amount of money you actually need, depending on your business collateral and credit, making it challenging for new businesses to get the funding they need.
Invoice factoring is the sale of your company’s invoices to a factoring company (or “factor”), which advances up to 80–90% of the invoice’s value. The factor then handles collections from your customers, paying you the remaining invoice value once the balance is settled. For this service, the factor charges a small percentage of each invoice’s value in fees, costing only pennies on the dollar.
One significant advantage of invoice factoring is its flexibility, giving you a short-term financing solution designed to provide the working capital your company needs today. Invoice factoring can grow alongside your company, and you can pick and choose which accounts to sell invoices from. Factoring applications are typically approved within days rather than weeks, making them a much faster way to boost cash flow. When debating invoice factoring vs bank loans, this speed can be a critical factor for many businesses.
Additionally, invoice factoring doesn’t entail the same interest rates, monthly payments and years-long payback terms as traditional loans. The money the factor advances you is your money, with each cash advance paid off by your customer when they pay your factor. Because of this, invoice factoring is not considered debt, making it a good option for businesses looking to avoid opening new lines of credit.
Invoice factoring can be an excellent choice for newly established businesses. Banks will often deny small business owners loans due to their limited credit history, but factoring companies are much more flexible. While your company’s finances are still considered during the approval process, your credit is much less important as you are not the one repaying the advance: your customers are.
Pros and Cons of Invoice Factoring
Quick Access to Cash: Invoice factoring provides immediate working capital. Typically, you can receive cash in a few days, which is crucial for covering urgent business needs.
No New Debt: Unlike loans, factoring doesn’t incur debt; you’re essentially selling your outstanding invoices at a discount.
Easier Approval: Approval for invoice factoring generally focuses more on the creditworthiness of your customers than your business’s credit, making it accessible for businesses with less established credit histories.
Flexible Terms: You can choose which invoices to factor and when, offering flexibility to manage cash flow according to your business’s unique needs.
Debt Collection Assistance: The factoring company handles collections, reducing your administrative burden and allowing you to focus on running your business.
Costs More Than Traditional Loans: The fees for invoice factoring can be higher than the interest rates on bank loans, especially if your customers delay payments.
Dependent on Customer Credit: The success of invoice factoring is contingent on your customers’ ability to pay, which might be unpredictable.
Not for All Types of Businesses: Businesses without invoice-based sales (like retailers) might not be able to use this financing method.
Pros and Cons of Bank Loans
Lower Interest Rates: Typically, bank loans have lower interest rates compared to other financing options, making them a cost-effective choice over time.
Predictable Payments: With fixed interest rates, businesses can plan their finances around regular, predictable payment schedules.
Credit Building: Regularly paying off a bank loan can build your business’s creditworthiness, making future financial dealings easier.
Lengthy Application Process: Obtaining a bank loan can be time-consuming, often requiring extensive documentation and weeks of waiting for approval.
Strict Eligibility Requirements: Banks typically have stringent credit and collateral requirements that may be challenging for newer or smaller businesses to meet.
Inflexible Terms: Once the loan terms are set, they are usually not adjustable, making it less adaptable to changing business needs or unexpected downturns.
Increased Debt: Taking out a loan increases your business’s debt burden, which can be risky, especially if the business’s income is uncertain.
Invoice Factoring vs. Bank Loans: The Bottom Line
When it comes to invoice factoring vs. bank loans, both can be viable ways to fund your business operations. However, invoice factoring is a much quicker and easier method to secure funds and grow your company’s cash flow. And with your factor handling collections, you can spend more time doing what matters most — running and growing your business.
Ready to learn more? Discover if invoice factoring is the right fit for your business!
Ernane Iung is a seasoned C-suite executive with a 28-year dynamic career across four continents, including two decades in São Paulo, Brazil, where he held key roles with renowned multinationals such as GE, Whirlpool, Philips and Oster.