Invoice factoring and invoice financing can help small businesses unlock capital tied up in unpaid invoices. Deciding to sell your invoices or borrow against them is a big decision that could impact customer experience, future lending, and profits.
This guide breaks down the differences between invoice factoring and invoice financing. Learn how each option works, what it costs, and how to choose the best short-term cash flow solution for your small business.
What is invoice factoring vs. financing?
Invoice factoring is when you sell your unpaid invoices to a factoring company, meaning the financial institution collects payment from your customers. With accounts receivable (AR) or invoice financing, you borrow against your invoices instead of selling them. You bill and collect from clients, then repay the lender.
Invoice factoring vs. invoice financing: How each option works
Factoring receivables (selling your invoices) can provide fast cash, sometimes within 24 to 48 hours of invoice verification. It takes longer to set up invoice financing (borrowing against your invoices), but once approved, draws can be the same day or next day. Below, we explore the differences between invoice factoring and financing.
Comparing costs, fees, and effective APR
Generally, invoice factoring costs more than invoice financing because you’re paying the company to handle collections, follow-ups, and payment processing. If you have effective collection strategies, AR financing can be cheaper and more predictable.
With factoring, you pay a fee every 30 days until the customer pays the factor company. This can range from 1% to 4%, based on your industry and customer credit. Because the fee is charged monthly, the effective annual percentage rate (APR) can range from 30% to 60% or more if your clients take 60 or 90 days to pay. Other costs include fees for lockboxes, credit checks, and wire transfers.
With invoice financing, a standard interest rate (APR) applies, making it easy to calculate accounts receivable loans. Other costs include maintenance and draw fees. You could incur additional costs if your receivables quality declines due to slow payers, disputes, or invoicing errors.
Understanding qualification and collateral
It’s easier to qualify for factoring than AR financing because factors look at the creditworthiness of your customers. But invoice factoring often requires a blanket lien (UCC-1 filing), which can prevent you from accessing U.S. Small Business Administration loans or other funding until it’s released.
Invoice financing assesses your entire business and AR processes to determine whether your receivables are current and well managed. However, lenders may file a lien only on accounts receivable or request a personal guarantee or other collateral, such as inventory or business assets.
Generally, invoice factoring costs more than invoice financing because you’re paying the company to handle collections, follow-ups, and payment processing. If you have effective collection strategies, AR financing can be cheaper and more predictable.
Evaluating customer notifications and impact
The impact on customers is a key difference between invoice factoring and invoice financing. Customers aren’t affected if you borrow against unpaid invoices. If you require cash on delivery or have ongoing contracts, you may prefer invoice financing because you maintain control over customer communication and collections.
After selling invoices, factors issue a notice of assignment (NOA) informing customers to pay them, not you. Customers may be confused or continue to send you payments, delaying the funding process. Factors buy current invoices, not past-due accounts. Only debt collectors receive compensation when they recover past-due accounts.
Knowing when to use invoice factoring vs. invoice financing
Invoice factoring works well for small businesses with higher margins but longer billing cycles. Examples include staffing agencies, trucking companies, distributors, and janitorial contractors.
Use invoice factoring when you:
- Need cash quickly but don’t qualify for a traditional line of credit.
- Have customers who pay slowly but are creditworthy.
- Want to outsource collections to reduce administrative burdens.
- Have higher profit margins to absorb fees.
Invoice financing is a better fit for small businesses with thin margins that need steady working capital. Examples include information technology service firms, subscription-based business models, professional service providers, and commercial cleaning companies.
Use invoice financing when you:
- Want predictable costs and interest rates.
- Need ongoing working capital for payroll or supplies.
- Prefer to manage customer communications and collections.
- Have effective invoicing and receivable processes and can run AR aging reports.
- Require a revolving credit line rather than one-off cash advances.
Top alternatives to invoice financing or factoring
Many alternative lending options exist to fill cash flow gaps for SMBs. In addition to factoring or AR financing, nonbank lenders may offer short-term loans, equipment financing, or other financial products. You may also qualify for small business grants and other funding programs with lower rates.
The best short-term cash flow options for small businesses should solve today’s challenges without putting you in a bind down the road. Applying for small business grants can take longer than applying for nonbank loans, but they don't require repayment.
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