Accounts Receivable Financing vs Invoice Factoring​ | Connect2Capital (2024)

A healthy cash flow is vital for any successful business, and there are a couple of services available that can free up money over the short-term. These are known as “invoice factoring” and “accounts receivable financing.” These services can be useful if you send out invoices and your customers don’t pay immediately, as they can provide upfront financing based on several areas.

We’ll explain what each one is so you can decide if either service is a good fit for your business financing needs.

When You Might Use Invoice Factoring or Accounts Receivable Financing

These services are specifically designed for businesses that need to wait for invoices to be paid. If your business receives payment before supplying goods or services, or gets paid immediately after, these options don’t apply to you. If you normally wait days, weeks, or months to be paid by customers, these services can close the cash flow and financial gap between sending invoices and getting money in your bank account.

Invoice Factoring, Explained

If you decide to use invoice factoring, a factoring company buys and owns your outstanding invoices and deposits a lump sum with you. This is how it works:

1. You have outstanding invoices that are due to be paid by customers.
2. You engage with an invoice factoring business to buy the invoices from you.
3. The invoice factoring business “buys” your invoices and forwards you a lump sum.
4. This lump sum is typically a percentage of the total invoice value.
5. The invoice factoring business collects on the invoices and deals with your customers, including payment requests and late payment fees.
6. When the invoices are paid, the invoice factoring company forwards you the difference, less their factoring / discount fee.

Here’s an example of how this might work in practice.

• You have outstanding invoices worth $10,000.
• The factoring company charges a 4% fee, or $400.
• Of the remaining $9,600, they forward you 80% of the value, $7,680.
• Once the invoices are paid, they send the remaining money, $1,920.
• If you have any other payments to make, they will be deducted from this final amount.

Invoice Factoring and Discount Fees

The amount that a factoring company charges for financing can vary based on several factors:

• The number of outstanding invoices.
• The total value of outstanding invoices.
• Your business sales volume.
• The industry you operate in.
• The overall creditworthiness of your customers.
• Who is responsible for unpaid invoices (you or the factoring company).

Some factoring businesses charge an upfront fee, while others will charge interest on unpaid invoices. The most common type of fee is a “tiered factoring Fee.” In this arrangement, the invoice factoring company charges your business interest on the amount and duration of outstanding invoices.

These fees can run to around 1.5 percent to 2 percent per month.

Accounts Receivable Financing, Explained

Accounts receivable financing, also known as invoice financing, is slightly different to factoring. The main difference is that you retain ownership of the invoices and the responsibility of collecting payments on them. Here’s how it works:

1. You have outstanding invoices that are due to be paid by customers.
2. You engage with an accounts receivable financing business and offer your invoices as collateral.
3. The accounts receivable financing business advances you a percentage of money against those invoices and charges you interest on this advance.
4. You repay the advance in regular installments, typically weekly or monthly.
5. You retain control of collecting on the invoices and dealing with your customers.
6. The accounts receivable financing company will charge you interest as long as they are owed money against your invoices.
7. If you default on the loan and fail to repay it, the financing company can take your invoices and collect on them as compensation.

Here’s an example of how this might work in practice.

• You have outstanding invoices worth $10,000.
• The accounts receivable financing company asks for your invoices as collateral and forwards you 90 percent of the value, $9,000.
• You repay the advance weekly over 90 days, at an interest rate of 25 percent a year.
• Your payment every week would be around $716.
• The total interest you would pay would be around $300.

You can work out likely costs with this short-term loan calculator.

Accounts Receivable Financing Fees

The interest rates charged on invoice financing do vary quite widely. They can range from as low as 1 to 1.5 percent per month, up to 3 to 5 percent per month. Rates vary depending on the number and amount of your invoices, the industry you operate in, whether you’ve taken out previous loans, the creditworthiness of your customers, and several other factors.

Which is Better, Invoice Factoring or Accounts Receivable Financing?

The service you choose depends on your business needs, and how you intend to settle up.

• If you want to retain control of the payments process, choose accounts receivable financing.
• If you’d rather hand off payment collection to another company, invoice factoring could be a good idea.
• If you want to make regular payments, choose accounts receivable financing.
• If you want the amount you owe to be deducted from what the business owes you, and to get paid the remainder, less a fee when customers pay, then invoice factoring is the way to do that.

Sometimes, There’s a Better Option

Both of these options can be expensive, with fairly high fees. There could be a better way. Here at Connect2Capital, we provide specialized loan matching services to startups and other small businesses. The interest costs associated with these loans can often be lower than that charged by factoring or accounts receivable financing companies.

It could also be difficult for a brand new company to get invoice factoring or accounts receivable financing because they don’t have a history of cash flow or repayments. While an existing business may get access to these services, we’d still recommend investigating business loans and comparing costs.

Try out our loan matching tool today.