We spoke with Bernadine Geary, Director, Cashflow Finance at Fundamental Business Finance, who provided some insights to the...
Invoice Finance vs. Factoring: The Devil’s In The Detail
"Know the difference between factoring & invoice finance"Team Waddle
Invoice Finance and invoice factoring are two financing terms which are thrown around, confused and widely misused by many lenders in the marketplace.
Important: Waddle’ cloud accounting add-on is a unique funding program in Australia and even though it falls under the category of invoice financing, it vastly differs to “traditional” invoice financing products on offer in Australia from banks or non-bank providers.
At first glance, it’s very easy to get confused as both funding products base funding on the same asset of your business, however, fundamentally there are significant differences. It’s critical to understand the mechanics behind each product and how it will affect your businesses access to funding, administration load, and transparency in pricing.
Here’s a closer look at the similarities and differences to help you make the right choice.
How Invoice Finance and Factoring Are Similar
Invoice finance and factoring provide your business with money based on the value of your outstanding invoices. In both cases, the factoring or financing company charges a fee or interest rate for the service. However, that’s pretty much where the similarities end.
How Invoice Finance and Factoring Are Separated
When working with a typical factoring company, you’ll receive a percentage of the total value of your invoices—typically about 80 percent of the face value. The factoring company withholds the rest of the invoice’s value in reserve until your customer pays the invoice. The reserve (sometimes called a rebate”) is held for up to one month in some cases, however, generally factoring companies will release the balance once per week.
When you use invoice financing from Waddle, however, you get granted a line of credit against the total amount owing against each customer you wish to fund, amounts are not based on each invoice, and retention or rebates do not exist. As you draw down funds against outstanding customer payments, any surplus funds are automatically swept back to your account daily for immediate use in your business.
How fast is the funding process?
Both invoice financing and factoring are faster than traditional bank loans with their lengthy approval processes. However, there are significant differences between factoring and invoice financing. With factoring, you’ll typically wait, sometimes up to three weeks to get the money you need. With Waddle’s invoice financing, you simply connect your accounting software to Waddle and receive an offer, accept and be funded withing 24-48 hours.
How much does it cost?
Remember the 20 percent of your invoice value that the factoring company withholds? Once your customer pays the invoice, you’ll get the 20 percent back…well, maybe some of it. The factoring company will charge a fee based on the time it takes the customer to pay the invoice and levy the fees on the face value of the invoice instead of what you borrow or get advanced (yep that’s a hidden cost you never thought about). The longer the customer takes to pay, the greater the costs. Also, factors may charge processing fees, EFT fees, yearly management fees or other hidden fees that can quickly add up. All of these costs can eat into your 20 percent—and, ultimately, your profit margins.
Waddle’s invoice finance is typically always more affordable than traditional factoring and is comparable to some bank loans. You will only be charged on what you draw down based on a simple yearly interest rate which is similar to an overdraft from a bank. You also have the flexibility to repay your credit line at any time to reduce your interest charges. There are no hidden costs, yearly fees or processing fees to confuse you.
Does it work for all businesses?
You don’t need to be a large company to use traditional invoice factoring. However, you do need to do a substantial amount of invoicing to be accepted by the factoring company, and some companies will restrict the size of invoices they will fund, e.g., Nothing under $10,000 per invoice as most factoring companies are highly administrative and cannot process small invoice volumes.
You may also be required to enter into long-term contracts with the factoring company that locks you into the financing even if you decide later that you aren’t happy with the service. This could be a problem if you’re seeking to finance as a one-time, short-term solution or just don’t require the funding any further.
On the other hand, businesses that require ongoing, once-off or wish to access funding only during certain cycles of the year can use Waddle’s invoice financing without being tied down or incur unnecessary costs if the funding line is unused.
It’s easy to apply, taking just minutes to set up an account. Also, you’ve got the flexibility to finance any customer you want, at any time. Maybe you’d like to exclude some of your customers from funding, or just choose to finance certain customers during seasonal periods of the year? No problem.
Who collects my invoices?
With traditional factoring, the factoring company takes over collections for the invoices that they have financed. This might work for you if you own a small business without adequate resources or time to handle your own collections. Maybe you’d like having a finance company take over this part of the business for you. As part of the financing, you must disclose to your customer that you are financing your invoices and have given up control to a third party to collect invoices directly if they wish.
However, if you’re like most business owners, you don’t want your customers or clients knowing that you have financing in place (even though most do).
If they find out that you’re using factoring, they might think that your business is in trouble and may have different perceptions about how you are trading. Even in the best-case scenario, there’ll be some confusion about why a third-party company is suddenly contacting them about a payment they owe to your business. If you don’t want your customers to be confused, you have to give them notice in advance and carefully explain why you are handing collections to a third party.
When you use Waddle’s cloud accounting add-on to extend a line of credit against your invoices, you stay in complete control of collecting on your invoices. Your customers never know that Waddle is involved, since there’s no interference in your relationship with your clients.
Hidden costs in administration
Invoice Factoring companies run their operations using third party software which is either desktop based or more recently online. The system works by requiring clients to upload invoices and debtor information on a regular, ongoing basis. When you first sign up for factoring, depending on how many customers or invoices you have this process can take days or even weeks to get all of this data into the factors system.
Each time funding is needed the business owner must enter or upload a schedule of invoices and then forward copies of the invoice with supporting documentation. If you have multiple invoices and customers, this process can take hours if not the entire day dedicated to each week for funding requests.
When is comes to knowing who has paid you will need to rely on the factoring company to reconcile the payment and enter into their system. Only then can you get visibility over customer payments. Accounting for factoring fees and costs can be a myriad of terms like administration fees, discount fees, management fees, factoring fees, chargebacks, recourse fees, etc.
Waddle’s invoice financing removes 100% of any of the administration mentioned above by syncing all of this information with your accounting software in real-time without any additional work. Any updates made in your accounting software sync with Waddle and any updates in Waddle sync with your accounting software via a dedicated two-way data exchange.
Fees and charges are structured just like bank loans with draw downs, repayments, and interest charges. Customer payments get displayed in your dashboard just like you would expect with your regular bank account for you to reconcile against customer invoices.
So invoice factoring or invoice finance?
Only you can decide whether invoice financing or factoring works best for your business. Waddle’s invoice finance is only suited for tech-savvy business owners that utilise the benefits of cloud accounting.