When a company makes a large sale, the may do so on credit terms.

This means that for a designated period, a business has less inventory available for sale, but no funds to account for it.

While a business waits for the buyer to pay the invoice, interim expenditures may still arise, such as covering payables, purchasing resources and paying employees.

Remaining financially liquid while waiting for payment of a large payable can be difficult. That’s why businesses are increasingly turning to invoice financing to help bridge the gap between the fulfillment of an order and receiving payment.

How does invoice financing work?

There are two methods of invoice financing: invoice factoring and invoice discounting. They are similar in that both result in a financier providing funds to a supplier according to existing invoices that have yet to be paid by the supplier’s customers.

However, there are some key distinctions between the two methods that are important to understand.

What is invoice factoring?

With invoice factoring, the supplier sends its existing invoices to the financier, who then provides a percentage of the total amount of outstanding debts to the supplier, typically between 60% and 85%. The financial institution is now in charge of collecting payments from the supplier’s customers.

Once the supplier’s clients pay the financier for the full amount of the invoices, the financial institution will release the remaining 15% to 40% of the funds to the supplier. The borrower will then pay associated fees or interest to the financier.

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Which is best: Invoice discounting or factoring?

Both processes have benefits and drawbacks and the financing method elected should be dependent on the business’s situation and objectives.

Before choosing an invoice financing method, consider these questions:

1. Do you want the financing arrangement to be disclosed to your customers?

If you have a strong relationship with your customers and want to continue working directly with them, invoice discounting would work best for your business. Some businesses do not want customers to be made aware of any funding lines being used to support the transaction.

There may be concern that, by introducing a financier, a third party in the relationship, an unfavorable image may be conveyed, especially if the buyer has had a poor experience with financiers, or, factoring companies before.

If you don’t mind your customers knowing the arrangement you have with the financial institution, factoring can work well for your situation.

2. Do you want to maintain control over collecting payments?

If so, discounting is the way to go. If you do not mind the financial institution assuming the responsibility of collecting payments, factoring may be a good choice if you want to save time etc.

3. Is your company in good financial standing?

Financiers typically reserve invoice discounting for companies with good financial health and a positive balance on their books. This is because it is less risky than factoring, where the financier has direct contact with the supplier’s customers who will eventually pay the invoices to the financier.

Since discounting keeps the financier removed from customers, the lender has less control over the situation, thus creating more risk. If your company is not in good financial standing, your best option may be invoice factoring.

4. Do you want your relationship with the financier to be ongoing, or would you prefer to use invoice financing on a case-by-case basis?

Invoice discounting typically involves an ongoing relationship, where the supplier provides the financier with a monthly invoice report. This invoice report helps the financier determine how much cash it can provide to the supplier without excess risk.

Invoice factoring is based on individual invoices of the supplier’s choosing. With this method, a supplier might choose to pursue invoice factoring to bridge the gap between the fulfillment and payment of large orders.

Alternative lending is different than traditional bank loans

Invoice financing is considered as an alternative lending strategy. Businesses that pursue this option should research the differences between traditional bank loans and invoice financing.

One important difference between traditional lending products and invoice financing is regulation. Invoice financing is not currently regulated under the Australian Securities and Investments Commission (ASIC) Act 2001.

However, an explanatory statement for ASIC Corporations (Factoring Arrangements) Instrument 2017/794 noted that financial companies that engage in factoring should:

  • Provide their clients with written copies of their terms and conditions; and
  • Have an internal dispute resolution process they adhere to when problems arise.

Companies that pursue invoice financing should do so with a reputable company that has the requisite technology and knowledge to carry out transactions securely and professionally.

Another critical distinction is the time it takes to obtain funds. Traditional bank loans are long processes that involve credit checks and long waiting periods before funds are delivered to the borrower.

With invoice financing, payment is nearly immediate – typically within 48 hours of the supplier providing the financier with their invoices.

How UnLockB2B can help businesses improve cash flow

UnLock understands the challenges associated with waiting on payments or dealing with credit terms which are not suited to your requirements. That’s why our platform gives buyers and suppliers a quick and easy way to improve their cash flow by paying invoices on supplies and on delayed terms from clients.

With our Payment Gateway, both buyers and suppliers sign up for UnLock. When orders are placed through the Payment Gateway, UnLock quickly processes them and pays the supplier within 24 business hours. The borrower then pays UnLock in installment periods of up to 90 days over a 12-month rolling facility.

The Payment Gateway gives buyers and suppliers more purchasing power that allows them to grow their businesses

To learn more about how UnLock can help your business increase working capital, talk to one of our experts today.