Every company needs startup money and ongoing funding to stay afloat. If your clientele is established and you consistently have positive cash flow, you’ll attain self-sustainability and be able to operate your company permanently. However, you’ll need a funding solution if you need help getting started, if seasonal fluctuations affect your revenue creation, or if your clients aren’t paying you on time.
Most business owners look to bank loans for funding solutions in these difficult financial circumstances. Nevertheless, small and midsize businesses can sometimes need help satisfying loan qualification standards and the loan’s stringent covenants.
Therefore, it may be preferable to use invoice factoring instead. But how does invoice factoring differ from bank loans, and which is the best option for small businesses?
Small Business Loans
Typically, when a business needs working cash, it will approach Traditional banks in an effort to obtain a small business loan. However, many companies discover that getting approved for a small business loan can be complex as they go through the application process. Even just filling out the loan application requires much time, work, and documentation gathering.
Furthermore, many businesses that complete the small business loan application procedure receive a denial after all their time and effort.
However, with invoice factoring, the factoring company process is typically quick and easy compared to traditional banks. Nevertheless, applying for invoice factoring still requires thoroughness and attention to detail.
While the process is typically quicker and easier than traditional bank financing, applying for invoice factoring services still requires thoroughness and attention to detail. They may be a government factoring company or a private one and needs only a few crucial documents to access an applicant’s company. Nevertheless, the procedure can be finished in a matter of days rather than weeks or months.
A revenue-based alternative finance option called invoice factoring is frequently mistaken for a small business loan. However, the application procedure and the financial products are dissimilar.
By selling your existing unpaid invoices to a factoring company at a slight discount, you can obtain immediate working capital equal to the amount of the factored invoices. Customers and businesses typically agree to pay invoices within 30, 60, or 90 days. Even though establishing a payment plan with your clients might help you predict projected revenues by quarter or month, actually collecting those invoices can be far more challenging.
Here’s an illustration of how invoice factoring works:
An invoice from Company A is for $10,000. The factoring company consents to pay $9,700 ($300 charge) for the invoice today. The advance, which in this case amounts to $8,245 or 85% of the invoice’s value, is then deducted from Company A’s account. After getting in touch with the customer of Company A, the factoring company collects the total amount of the invoice and, once paid, provides Company A with the remaining $1.455 balance.
What distinguishes factoring from loans?
Small business loans typically need more and different kinds of documents to be approved. For example, to qualify for a small business loan, you’ll need to show proof of your company’s credit history and your implied ability to pay back the loan. Sales predictions, prior loans repaid, and current cash flows are a few examples of the documents that may be needed to demonstrate revenues and, consequently, the ability to repay.
With invoice factoring or government contract factoring, your customers’ creditworthiness—rather than that of your company—is the main concern. The ability of the client to pay back the invoice amount is evaluated more closely than the company seeking factoring because the factoring company will be collecting payments for invoices directly from customers. This is a crucial distinction because most companies seeking finance have less well-established credit, necessitating the need for outside funding.
Which is better: Bank loans or invoice factoring?
Is invoice factoring preferable to bank loans? The answer is based on the stage of development your business is at. A traditional bank line of credit or a company loan are ideal options for offering a cost-effective finance solution for steady businesses with strong credit. However, most SMBs are either new businesses, need to close a cash flow gap, or are expanding in some way. Therefore, invoice factoring can be the perfect working capital option for these businesses.
In a head-to-head comparison, invoice factoring is clearly the best option if you have outstanding bills, don’t have the credit for a traditional bank loan, or need immediate financing.