In a recent small company study, approximately 60% of respondents said COVID-19's influence on the economy had severely or very negatively impacted their cash flow. While frivolous spending and large purchases are undoubtedly under scrutiny, many firms are also scrutinising their receivables. They are exploring invoice factoring and invoice financing to enhance cash flow to their businesses as quickly as possible. What exactly are accounts receivable, and how may factoring receivables benefit your cash flow? These are essential issues, and there are financial considerations to be made before settling on these financing options.
Many firms, particularly those in the business-to-business (B2B) sector, have cashflow issues.
The most apparent answer to a cashflow difficulty for many organisations is to seek for a business loan. However, this normally necessitates a lengthy application and approval procedure. There are two more common approaches for resolving it more quickly:
- Receivables financing
- Invoice factoring
What is Factoring?
Factoring is a type of invoice financing in which firms auction off outstanding invoices to factoring companies in order to improve their financial health. A third party will pay you the majority of the invoice immediately and collect payment directly from your clients.
Define receivables financing
Receivable finance is similar to invoice factoring in that outstanding invoices can be sold to factoring providers for immediate operating cash. The difference between receivable finance and debt financing is that you retain ownership of the unpaid invoice and are responsible for collecting payment from clients.
What is the difference between receivables financing and invoice factoring?
The differences between Invoice factoring and receivables financing are:
- Invoice factoring is frequently a faster alternative than receivable financing to obtain the value of outstanding invoices.
- Invoice factoring frequently includes collections, but invoice financing does not.
- Invoice factoring offers a greater proportion of the invoice value than invoice financing.
- Fee structures change between invoice financing and invoice factoring.
Difference between the service providers of receivables financing and factoring.
Banks, in general, provide receivables finance. Fintech-focused alternative lenders offer both loan and factoring services. There are five major distinctions between what banks and receivables finance providers (also known as factors) provide:
- Speed of approval: Banks have generally severe due diligence processes, while many fintech factors employ technology to provide practically quick judgements.
- Collections process: Banks do not engage in the collection of invoices, while several factors do.
- Process category type: Banks make loans (with invoices as security), whereas factors buy invoices directly. This difference can have an impact on credit ratings.
- Amount of invoice value provided: Banks typically offer a lower percentage of the value of outstanding receivables (75-85%) than factors (up to 99%).
- Fee structure: Bank fees are depending on the interest rate on the loan. Factors charge a percentage of the entire invoice amount (typically between 1% and 3%).
Factoring or Receivable Financing, Which is Better?
The service you select is determined by your company's demands and how you want to settle up:
- Choose accounts receivable financing to maintain control over the payment process.
- Invoice factoring may be a suitable option for offloading payment collection to another firm.
- Choose accounts receivable financing to make regular payments.
- When you want the amount you owe subtracted from what the firm owes you and the balance paid to you, less a charge, when clients pay, invoice factoring is the way to go.
When You Might Use Invoice Factoring or Accounts Receivable Financing
These services are developed exclusively for organisations who must wait for invoices to be paid. If your company receives money before or after providing products or services, these alternatives do not apply to you. If you generally have to wait days, weeks, or months for consumers to pay you, these services can help you bridge the cash flow and financial gap between issuing invoices and receiving money in your bank account.
Receivables financing vs factoring: Which one should you choose?
Business owners are frequently required to make cashflow choices quickly and under duress. At first appearance, the distinction between factoring and financing appears to be minor. The implications, however, may be felt in both the short and long term.
We propose that you evaluate the following three questions to help you find the best solution:
1. How urgently is cash/capital needed?
2. How much capital is needed?
3. How much of an issue are collections?
The uneven relationship between large customers and smaller suppliers is unaffected by supply chain finance. Factoring has been established for hundreds of years because when a smaller supplier sells to a larger client, the larger customer decides when to pay the invoice, frequently regardless of the payment conditions they agreed to.
This connection is unaffected by supply chain funding. The buyer initiates and controls it. The buyer selects which suppliers may participate, when they will pay, and how much of a discount they will expect. Some buyers may lack the funds, technology, or motivation to give it to all of their suppliers, instead focusing on their largest suppliers. Others may provide it today only to withdraw it without notice the next day due to changes in their cash flow status or priorities. The customer retains control, and the provider is at their mercy in terms of payment.
Conclusion
Ensuring healthy cashflow is critical for every organisation, and there are more alternatives than ever for doing so. Although bank loans are still available, receivables finance and factoring are popular and tried-and-true methods for firms to swiftly access operating capital.
The two systems differ in the following areas: approval speed, collections procedure, process category type, quantity of invoice value offered, and charge structure. When looking for a cashflow solution for your company, consider fintech suppliers that may be able to give an appealing option.
There are various tariffs and value-added services to consider, as well as various concerns to prioritise. When used properly, both of these solutions may contribute significantly to the success of your organisation.
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