Comparing Trade Credit vs Invoice Factoring

Net-30 terms can help you close more deals, but they also push back the cash you're owed. To bridge the gap, many business owners turn to invoice financing, factoring, or trade credit.

All of these options provide liquidity but differ when it comes to cost and how they affect client relationships. So, before you jump into a decision, here's each option explained and how they compare.

Invoice Financing vs. Factoring vs. Trade Credit: Quick Overview

When working capital disappears, it's generally because a business has a lot of outstanding money tied up in invoices.

Three main options solve this problem, and while they all aim to free up cash that's locked in receivables, they go about it very differently:

• Invoice financing: You borrow against unpaid invoices while you carry out the collections process.
• Invoice factoring: You sell your unpaid invoices to an invoice factoring company, which then collects payments and takes a fee.
• Trade credit: Payment terms are extended to the buyer, using net-30, net-60, or net-90, along with buy now, pay later options.

All collection methods allow you to manage cash flow issues by getting some or all of the money upfront. However, they have different implications for control, cost, and the customer experience.

Financing vs. Factoring: The Details

Both invoice financing and factoring enable you to recover outstcalanding invoices, providing you with immediate cash. However, the fees are steep.

Invoice financing

Invoice financing (also known as accounts receivable financing or invoice discounting) allows you to take out a loan against your outstanding accounts receivable.

Lenders will give you as much as 90% of the outstanding value, providing you with cash. Once your customers have paid up, you pay back the lender, plus interest and fees.

The caveat is that it's down to you to collect payments. And the longer customers take, the higher the fees you pay.

When looking at invoice financing vs. factoring, the former is typically the more subtle option. This is because your customers continue to pay you directly, so they won't know that you've taken this route.

However, you can expect to pay fees of up to around 5% per invoice.

Invoice financing example:

• You finance a $75,000 invoice with net-60 payment terms.
• The invoice financing company pays 85% upfront, giving you $63,750 right away.
• The lender charges a 2.5% fee per 30 days the invoice goes unpaid.
• The client pays after 60 days, so the total fee is 5% or $3,750.
• The lender pays you the remaining balance (minus the fee) of $7,500.
• Overall, you received 95% or $71,250 of the total invoice value.

Invoice factoring

Invoice factoring (also known as accounts receivable factoring or debt factoring) works by selling your outstanding invoices to a factoring company.

They pay you a portion of the invoice amount right away and take over the responsibility of payment collection. Once the factoring company has received all payments, they send you the remaining amount, minus its fees.

Although this is more hands-off for you, it does change the customer experience because they now have to deal with a third party.

Using a factoring company tends to be more expensive than using a financing company, particularly if invoices remain unpaid for a long period.

Invoice factoring example:

• You sell a $68,000 invoice with Net-60 terms to a factoring company.
• They give you 82% upfront, so you receive $55,760 right away.
• The factoring company charges a 2% fee per week until the customer pays.
• The company receives payment after five weeks, so the total fee is 10% of the invoice value, or $6,800.
• The lender pays you the remaining amount (minus the fee) of $5,440.
• In total, you received $61,200 or 90% of the value.

The Pros and Cons of Financing and Invoice Factoring

Both methods have some clear drawbacks, yet they remain popular because they also come with real advantages:

Comparing Invoice Factoring and Financing With Trade Credit

Trade credit is a standard B2B practice where suppliers allow buyers to purchase goods or services now and pay later. This can be using net payment terms or allowing the buyer to spread payments out over a set period of time.

Extending payment terms gives the customer ample time to pay, but it doesn't solve the problem of late payments or a lack of cash flow to cover short-term expenses.

This is where a company like Credit Key can step in and bridge the gap.

The customer gets flexible financing options, enabling them to make the purchase and spread the cost over several installments. You, the seller, get the full payment typically within 48 hours after approval, subject to applicable terms.

Unlike invoice financing and factoring, fees are fixed, meaning they don't escalate to sky-high amounts.

Flexible customer payment options

Offering flexible payment terms at checkout can increase conversions and order values, neither of which is achieved by using invoice financing or factoring.

Better for customer relationships

Unlike factoring and invoice financing, you remain in control of the buyer experience.

Customers get instant decisions and desirable terms, without you (or a company) chasing them for outstanding invoice payments.

Maintains a healthy cash flow

You receive payment typically within 48 hours per transaction, regardless of client payment timing. Plus, you receive the full amount (minus fees), so there's no waiting around for the remaining chunk of cash.

This is great for a business's cash flow and especially for small business owners, where cash flow is generally tight. You can access capital right away and immediately reinvest it.

Predictable costs

With invoice discounting and factoring, the fees will continue to increase until the customer finally pays. These fees eat into your profit margins, leaving you with less.

BNPL providers offer fixed fees, making it easier to forecast profits and protect your margins.

You know exactly what each transaction will cost upfront, regardless of payment timing. Therefore, financial planning is easier, and the sales ledger is simpler to manage.

Find the Right Fit for Your Cash Flow

Although factoring and invoice financing remain popular ways of unlocking cash, trade credit is an alternative that provides similar benefits.

The key difference comes down to cost and client experience, both of which tend to be significantly better with trade credit.

To understand more about the impact Credit Key can have on your business, we invite you to get in touch and explore our solutions.

FAQs

What is the average cost of invoice factoring?

The average cost of invoice factoring typically ranges from 1% - 5% of the invoice's total amount per month. This cost depends on the volume of invoices, the business's creditworthiness, and payment terms.

Is invoice factoring worth it?

Invoice factoring can be worth it for businesses that require immediate access to working capital to resolve cash flow issues. It's also a good solution for businesses with bad credit.

However, it's expensive, so it may be better to explore trade credit or invoice financing as lower-cost solutions.

What are the downsides of invoice factoring?

The downsides of invoice factoring include high fees and less control over client interactions. Additionally, because the factoring company takes over the outstanding receivables, it may require minimum invoice volumes or long-term contracts.