The Difference Between Factoring Invoices and a Bank Line of Credit
Most businesses reach a point, whether early in the startup process or as they gain traction, when cash flow becomes a concern. Fortunately, there are several avenues that companies can follow to finance their expenses and maintain cash on hand.
Choosing the right option for your company, however, requires an understanding not only of your financing needs but also of the benefits and drawbacks of the funding methods at your disposal. Two alternatives, invoice factoring and a bank line of credit, offer similar advantages but can have very disparate impacts on your company’s financial future. Read on to compare the two.
Bank Line of Credit
When a bank extends a line of credit, they are pre-approving the company to borrow against a set limit in whatever amount and at whatever frequency is required to keep the business running smoothly. Approval criteria for a line of credit are the same as those for a traditional bank loan though once you are approved you can access the line of credit whenever you need.
You will pay interest on the money you borrow against the credit line when you borrow it, albeit at industry-low rates. If you max out your line and need additional cash then you will have to apply for an extension with the bank, which can take a number of weeks and may require further documentation or collateral.
If you are considering a bank line of credit, your company should be established (at least one year old) and have a solid credit and collections history. In addition, if you have multiple owners or partners at least 80 percent of them must be on the application.
Invoice factoring is an alternative to conventional financing that advances cash against the value of your open invoices in exchange for the right to collect against them. You can be approved in as little as 3-5 business days with minimal paperwork, even if you are a startup or have a poor credit and collections history.
To factor, you submit your unpaid invoices to the factoring company for verification. They will then advance you up to 90 percent of the invoice amount within 24 hours and hold the remainder in reserve. When your customer pays the factor to close the invoice, the factor will send you the reserve amount minus their fees.
As with a line of credit, you only pay factoring fees for the time your invoice remains unpaid. While factoring fees are somewhat higher than the interest charged by banks, you will not typically have to repay the cash you receive. You can use invoice factoring as often as you need to receive as much cash as you need, as long as you have the open invoices to back up your request. Unlike a line of credit, your funding potential through invoice factoring is only limited by your company’s sales – and you don’t have to apply for extensions when your business picks up!
Which one should you choose?
Some final questions to ponder:
- If you borrow money to run your business, will you be able to pay it back from future revenue?
- How long can you afford to wait before a funding decision?
- Are your cash flow needs static or constantly changing?
- Are you prepared for unexpected expenses, or do you need a funding option that will adapt to emergencies?
The ultimate decision about your company’s funding needs is yours to make. Carefully research your options to make the best choice to carry your company forward.
Factor Finders works with a nationwide network of invoice factoring companies that can customize the ideal program for your business cash flow needs. Learn more about our invoice factoring services then contact us to receive a same-day application and proposal!