Invoice Financing vs Factoring: Which is Best for Small Businesses? (2024)

Many small business owners new to invoice funding wonder what the difference is between invoice financing vs invoice factoring. One important note is they are not interchangeable terms.

It’s important to know the difference between invoice financing vs factoring so that you can choose the best option for your business and your current situation. By the end of this post you’ll have the info necessary to do just that. (You can even use both options at the same time for different reasons, but we’ll get to that later.)

Without further ado, let’s define exactly what invoice factoring and invoice financing are.

Before we can really dig deep into the differences and reasons to use invoice financing vs invoice factoring, we should be clear on the pros and cons of financing an unpaid invoice. There are a few similarities between the two, but ultimately, the financing option often carries with it the same cons as a business loan.

In short, here is what you need to know:

• Customer not involved. Unlike invoice factoring, the customer is not involved when it comes to financing. The financing company never collects payment from your customers because you are paying back the business loan. This offers some peace of mind since there is no third-party in your business-customer relationship.
• Can be faster than factoring. Since your customer isn’t involved, the approval process is shorter and faster. Of course, since factoring can also take only a few days, the time savings with the financing option may not make a difference.
• Convenient access to working capital. One similar advantage between factoring and financing is that you get access to the money you need, fast. This makes solving common cash flow problems, like getting funding any time for payroll or big projects to grow your business, a cinch.
• Easy process. Another similarity between an invoice financing company and factoring company services is that the process tends to be easier than applying for a bank loan. AI, automation, and integration with accounting software can eliminate time-consuming paperwork and speed up your access to capital.

• Everything’s on you. A major difference is that you are on the hook for payment, not your clients. This means you have to keep up with payments, just like if you were paying a bank loan. The reason financing may not be the way to go is that you needed cash flow in the first place, but with financing you have to start paying it back quickly. Depending on your cash flow problem, financing could make the issue worse – not to mention also takes up time and focus that should be spent on your business.
• Smaller capital limits. Another disadvantage related to the financing option is that the working capital you can get access to might not be enough. Typically, you can only get small amounts of funding.

With these concepts in mind, let’s look at invoice factoring services.

Invoice factoring is a financial tool where a business owner sells eligible invoices to a factoring company. The business owner receives cash for the invoice amount, less any fees, ahead of the payment terms. The business owner’s customer, who is responsible for paying the invoice, instead pays the invoice amount to the factoring company according to the original payment terms. (See our post on the definition of factoring if you want to explore this more.)

Basically, an invoice factoring service waits months to collect the unpaid invoice payment from your customer while you put your funds to work immediately.

• More time, less stress. Since you aren’t tracking down accounts receivables and late payments, you get more time and focus back in your day. Your factoring company will manage collections for you. And a great factoring services company will treat your customers professionally, so you can have peace of mind. See our approach.
• Higher limits for capital. Unlike with the financing option, you’ll have greater access to working capital, better ability to take on large projects, and more support to cover expenses. When you work with us at FundThrough, you have access to unlimited capital when you factor invoices.
• Convenient access to working capital. Not only can you tap into higher limits, but you can streamline advances for payroll or expansion projects. Invoice factoring is often easy to apply for, and approval is faster than a traditional bank, making it ideal for fast-moving businesses who need fast cash flow.
• Easy process. Working with a best-in-class invoice factoring company like FundThrough means you can eliminate time-consuming paperwork with AI, automation, and integration with QuickBooks. Instead, you can rapidly submit your application, get approved, receive funding, and focus on your business.

• Customer involvement. The main concern most businesses have about invoice factoring vs invoice financing is involving their customer. Business owners and CEOs have worked hard for their customer relationships and are sometimes worried a factoring company could damage them. Totally understandable. The right invoice factoring company gets that and takes care to treat your customers with respect and professionalism. (See how we treat your customers.)
• Can be difficult to record in accounting. Factoring transactions can seem complicated to record in your books accurately. But they aren’t impossible to reconcile in your ledger. You just need a few additional steps. See our step-by-step guide for all the details.

Both invoice financing and invoice factoring give you access to fast capital. Both require less paperwork than traditional funding. Furthermore, both processes are incredibly fast.

Technically, financing is slightly faster, in some cases, than factoring. This is because invoice factoring loops in your customer. However, they’re both quick since even factoring only takes days. In addition to the length of time, it’s often helpful to ensure you are getting funded for the right amount, that the financing or factoring company is dependable and transparent, and that you’re set up to grow your funding as your business grows.

It’s important to note that, neither financing or factoring your outstanding receivables affects your credit. Therefore, it’s possible for small businesses with traditionally no credit or even “bad credit” to apply and get approved for funding, depending on the factoring company.

The key differences between invoice factoring and invoice financing are:

• Invoice factoring involves your customer, invoice financing doesn’t.
• Invoice factoring typically offers access to more capital than financing.
• Financing is more similar to a line of credit or loan—you are borrowing against your account receivables.
• Factoring is when you sell your accounts receivables, so it’s more similar to an advance.

The overall cost of invoice factoring may also differ from financing, depending on the company, the unpaid invoices submitted, and company policies.

Understanding the definitions is just the first step to choosing the right invoice funding option. Like anything, the differences are in the details.

For both invoice factoring and invoice financing, you receive cash for your eligible invoice ahead of the typical 30 to 120-day payment terms. Some of the differences are more obvious, and some less so. For example:

• Fee schedules. With factoring, the transaction fee is withheld from the advance before it lands in your bank account. When your client pays your invoice, there are no long-term commitments. With financing, a portion of the fee is added to each payment.
• Invoice totals. Oftentimes, large invoices are recommended for factoring, while smaller invoices are recommended for financing.
• Repayment plans. The business owner’s customer redirects payment to the receivable factoring company when an eligible invoice is factored. The customer pays the business owner directly for a financed invoice. (In both cases, the customer is only obligated to pay according to the invoice terms; it’s who they are paying that is different.)
• Parties involved. With factoring, the business’ customer is involved because they have to redirect payment. With financing, the customer isn’t involved.
• Mental burden. When business owners finance invoices, they have to make sure cash is available wherever payment is due to the financing company. When they factor invoices, they don’t have to keep an eye on their bank account because the fee has already been withheld from the advance. Additionally, the factoring company handles the payment collection and late payers. (At FundThrough, we always talk to you before contacting your customers.)

On the surface, it seems obvious: Customers push for invoices with long payment terms, creating a delay for business owners who need immediate cash – not another account receivable. This happens in businesses of all sizes and across industries, but it’s especially tough on small businesses.

According to a report from J.P. Morgan Chase, the average small business only holds enough cash for 27 days in reserve. In addition, 22% of small businesses struggle with cash flow issues, with only 38% getting approved for a traditional loan in the US. Yikes.

Lower, less established cash flow makes it harder to ensure there’s enough coming into their business bank account to compensate for what’s going out – and that’s not even taking into account cash needed to grow.

Simply put, invoice funding can help business owners make payroll, pay suppliers, and handle an emergency. But it can also be used to fulfill large orders or projects from well-known or creditworthy customers. Or ramp up production and service when you get a big break, and the bookings are rolling in. It’s a fact that having cash in the bank lets you grow your business. Funding invoices is one way to get it.

Getting back to why business owners fund invoices, those are all logical reasons, but they’re not the only reasons. We can’t ignore how much stress business owners are under when they need better cash flow. Not only is it a difficult problem to solve, but it also takes their attention away from the important work of serving their customers and growing their business. (If this is you, see if you qualify for FundThrough.)

So, which funding option is the right one? We asked our clients what they thought.

What can we learn from this? There are a few things we can see from the reality of businesses that use factoring and financing. The first is that financing gives customers fast and flexible funding best suited for smaller invoices. The second is that factoring is still fast and flexible, but also gives them more time back in their day, reduces complexity, and is best suited for larger invoices.

If you’re still struggling with which option to take, dive deeper into the pros and cons of both factoring and financing. Have a question that wasn’t answered? Our Ultimate Invoice Factoring Guide has you covered! If you know which solution is right for you and are ready to take the next step, see if you qualify for invoice factoring with FundThrough.

Invoice Factoring Benefits and Drawbacks

How Does Invoice Financing work?

Struggling with Unpaid Invoices? Here Are 6 Things You Can Do