Invoice Factoring vs. Lines of Credit for Payment Delays

Extending net 30, 60, or 90 payment terms to your customers is a common practice. However, you can be left waiting a while for invoices to be paid on products or services you’ve already delivered. This can lead to cash flow problems for an otherwise healthy and thriving business.

With financing methods like invoice factoring and business lines of credit, you can get an immediate cash injection to cover the gap until your accounts receivable balance out. Before picking one, you need to understand how these options can impact your process and customer relationships.

In this invoice factoring vs. line of credit comparison, we explain how each financing option works and take a closer look at how they can impact privacy, control, and customer sentiment.

Invoice Factoring vs. Line of Credit: How Do They Work?

When accounts receivable delays put a strain on a small business’s cash flow, financing can help cover expenses until customers pay their invoices. Two funding options that business owners might consider are invoice factoring and business lines of credit.

Here’s how these business finance solutions work.

Invoice Factoring

Invoice factoring, also known as accounts receivable factoring, is a type of financing where you borrow against your outstanding invoices.

Here’s how invoice factoring works. You sell your unpaid invoices to a factoring company. They give you a portion of each invoice amount upfront, usually 70% to 90%, and then they collect payment from your customers. Once a customer pays, the factoring company will give you the remainder of the invoice amount — minus a factoring fee.

You don’t need to worry about having good credit to use this financing solution because most invoice factoring companies are more concerned with the creditworthiness of your customers. That means even startups with limited or no credit history can sell their outstanding invoices.

Business Line of Credit

A business line of credit works similarly to a credit card. You’re given a credit limit, and you can withdraw money as needed for whatever your business needs. When you make repayments, your available credit replenishes, and you can borrow it again.

For example, let’s say you have a $75,000 business line of credit and withdraw $15,000, leaving you with $60,000 in available credit. After a few customers settle their invoices, you repay $5,000. Now, you have $65,000 in available credit.

When it comes to accounts receivable delays, a business line of credit is a better option than a traditional loan because it’s flexible and has a fast approval process. Depending on your lender, you might be able to apply within minutes and receive a decision in as little as six hours.

How Invoice Factoring and Business Lines of Credit Compare on Key Factors

Both invoice factoring and business lines of credit can help you manage accounts receivable delays. However, it’s important to understand the potential pros and cons, especially when it comes to privacy, control, customer relationships, and fees.

Privacy

When you sell your invoices to a factoring service, you’re putting your clients’ information into another party’s hands. This is known as a fourth-party relationship, and it can increase security risk. While any reputable financial company should have safeguards in place, you want to be careful about putting your client’s data at risk by introducing another access point.

With a business line of credit, your customers’ data isn’t involved in the application process or in the exchange of funds. You’re able to keep the invoices in-house, where you know everyone who has access to them.

Control

Privacy isn’t the only area where you give up control when you use invoice factoring — you also lose control of the process and customer communications. The biggest risk for a factoring company is a customer who doesn’t pay. They’ve already given you a substantial cut of the invoice amount, and they can’t recoup that money unless the invoice is paid in full.

You won’t be able to control what tactics the factoring company uses to get your customers to pay. Hiring a less-than-stellar service partner might open up your customers to being treated unprofessionally or feeling badgered.

Again, a business line of credit offers peace of mind since you remain in control of the accounts receivable process and customer interactions. You can even schedule automated follow-ups so customers aren’t receiving too many or too few communications about their invoice.

Customer Relationships

You’ve probably already noticed how your customer relationships might be negatively affected by invoice factoring’s lack of privacy and control. You won’t know who is accessing your customer’s data or how they're being treated. These poor experiences can erode customer sentiment and trust.

Aside from that, you may not want your business’s funding needs to be public knowledge. There’s certainly nothing wrong with strategically using financial solutions to help your business survive and thrive. However, if a customer learns you’ve sold their invoice to a factoring company, they might perceive it negatively or become concerned about your business’s stability. A fear of supply chain disruptions — even an unfounded fear — may motivate them to consider doing business with a competitor.

This is another area where a business line of credit wins out. Your financing needs and strategies stay private, so you don’t need to worry about a customer making assumptions about the strength of your operations.

Plus, when you’re in control, you have the freedom to work with your customers on an individual basis. For example, let’s say there’s a buyer you have a long-standing relationship with. They’ve been loyal to your company and have always paid on time. They reach out to let you know they’re going to be late on their current invoice. You have the ability to work with them by waiving your late fee or creating a payment plan as a way of honoring your relationship with them.

Fees

Both invoice factoring and business lines of credit come with fees. Which one is more cost-effective will depend on the provider. Let’s look at the potential charges.

With invoice factoring, a percentage of the invoice value will be withheld. This is called a factoring fee and is generally 1.5%-6%. In some cases, a factoring company may charge a higher rate for invoices that take longer to collect payment.

In addition to the factoring fee, there might be other service or documentation fees that contribute to the total cost. These additional fees are common because it allows companies to advertise a low factor rate and make up the difference through the additional charges.

With a business line of credit, there’s an interest rate that will only be applied to the withdrawals you make. If you have a $50,000 business line of credit and withdraw $10,000, the interest will accrue on the $10,000 you’ve borrowed, but not the $40,000 that’s still available.

A business line of credit may also have origination fees or draw fees depending on your lender.

Stay in Control With a Business Line of Credit

Financing isn’t only for struggling companies. It’s also a strategic solution for businesses with predictable, but uneven cash flows due to accounts receivable delays. When you compare invoice factoring vs. a line of credit as potential solutions, a business line of credit is the clear winner. It provides flexible financing and lets you maintain privacy, control, and customer relationships.

With Backd, an alternative financing provider, you can get a Business Line of Credit of up to $1 million and terms up to 12 months. The application process* is fast with straightforward eligibility requirements:

• $100,000 monthly revenue

• 650+ credit score

• Established business credit

• Based in the U.S. with a brick-and-mortar address

• Been in business for two years

Apply now and receive a funding offer within as little as 6 hours.**

*Your application, including the amount, cost, and approval, is subject to review and is not guaranteed. Terms and conditions subject to change without prior disclosure or notice.

**Decisions and funding may take additional time and not be same-day. Additional information may be required. Time to receive funds varies based upon your financial institution's receiving schedule and operating hours.