Is it better to take on a business loan? Or, are invoice factoring options the wiser solution? Discover the answer in this loan versus factoring guide:
Poor cash flow. It’s the reason why 82% of businesses fail and It can also severely restrict a business’s growth.
One of the things that can wreak havoc with business cash flow is unpaid invoices. To combat this, some companies choose to shorten their debtor terms. However, this can make your business less competitive, as certain customers might specifically vet for longer payment terms on invoices—especially if they’re in an industry with long payment cycles.
Fortunately, there is a quick, guaranteed way to turn unpaid invoices into cash. It’s called invoice factoring. Wondering how a loan versus factoring compares?
If you need cash flow fast, it’s important to know the differences between invoice financing and loan options. Both of these types of funding have their pros and cons.
However, in some cases, factoring might be a better solution. If you want to make the best decision for your business and turn its cash flow around fast, keep reading as we break down the differences between a loan vs factoring.
The Pros and Cons of Loans
Loans are a common form of business financing. While they can act as a form of capital, they do have various constraints, especially when needed for cash flow purposes.
Let’s take a look at the pros and cons associated with loans versus factoring for businesses. Doing so will help you see the advantages and disadvantages of the former.
The primary pro associated with business loans is they can be a cost-effective financing solution. Depending on the age, health, and credit score of your business, the interest rates on business loans can be relatively affordable. However, the interest rate you’re eligible for can differ widely. Therefore, this advantage to business loans will not apply in all circumstances.
Although business loans can come with reasonable interest rates—as mentioned above—this isn’t always the case. If your business is relatively young, your credit score is low, or your company is struggling financially, you will likely only be able to access higher interest rates on loans. The other con to business loans is that they can be difficult to apply for. In some cases, you might only be eligible for low-quality loans from less reputable lenders.
Besides this, you will only be able to receive a bank loan for the amount you have been approved for. In some cases, this could fall short of your needs. Lastly, loan applications are typically a lengthy process, with approval taking anywhere from 30, 60, or 90 days.
Pros and Cons of Factoring
To get a clear picture of the differences between a loan versus factoring, let us now examine the pros and cons of invoice financing.
Invoice factoring is the process of selling your business’s unpaid invoices to a factor. The factor then takes on the responsibility of collecting the invoices. You receive a percentage of the value of the invoices upfront.
Some factors offer upfront payments of up to 90% on the value of the invoices. Once all the invoices have been collected, you receive the remainder, minus the factoring fees.
While a small business loan can be advantageous if you are eligible for reasonable interest rates and can gain fast approval—invoice financing is almost tailor-made for easing cash flow issues.
What’s more, your business’s size, age, and credit score are not limiting factors.
There are several benefits to invoice factoring, particularly if you are having trouble qualifying for credit for your business.
Unlike with a small business loan, you can qualify for invoice factoring regardless of your business’s size, credit score, or age. As long as you have unpaid invoices, you may be able to have these factored.
Research shows that SMEs’ success at applying for business loans is directly linked to their age and size. If you’re struggling to get a small business loan, then factoring can be an ideal solution.
Another advantage of invoice factoring is the processing time. While a small business loan can take up to 3 months to be approved, invoice factoring can take as little as 24-48 hours. If you are facing cash flow issues, time is usually of the essence. Invoicing financing can assist your cash flow overnight.
Besides being quicker and easier to secure, invoice factoring also doesn’t add debt to your balance sheet. Because you are essentially “selling” your unpaid invoices, there is no resulting debt to pay off as there is with a loan.
A further advantage to invoice factoring is collection services. Collecting unpaid invoices takes up time and resources. If you leverage invoice financing, this task gets handed over to the factor. They then become responsible for collecting the invoices.
Lastly, with invoice financing, you have unlimited funding potential. As soon as you have a new batch of paid invoices, you can factor them.
Although factoring can be highly advantageous for facilitating cash flow and growth for your business, it does have a couple of cons.
Firstly, remember that the factor will take a percentage of the value of your unpaid invoices. Also, if you apply for recourse factoring, you still retain full liability for the outstanding invoices.
Generally, it’s best to choose non-recourse factoring. With non-recourse invoice factoring, you share liability with the factor. However, be aware that even with non-recourse invoice financing, you may need to reimburse your factor for particularly problematic invoices that turn into bad debts.
Lastly, don’t forget about the impact that a third party can have when collecting from your customers. If you pick the wrong factoring company, you might find their collection methods hurt your relationship with customers. Therefore, always ensure you go with a reliable factoring company that looks after your customers.
Loan Versus Factoring: Which Is Best for You?
While there are benefits to both loans and invoice factoring, in many cases, invoice factoring might be an easier solution for business owners.
When choosing between a loan versus factoring, the right decision will ultimately depend on your business and its needs. If you are struggling to find affordable financing, need cash quickly, or don’t want to be liable for a debt, invoice financing can be an effective and convenient option.
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