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The difference between invoice factoring and bank loans (and what’s right for you)

In difficult financial situations, most business owners immediately turn to bank loans as a financing option. While they can be a valuable and relatively inexpensive way to get the cash your business needs (especially in the short term), they aren’t always the best financing option. Instead, it may be better to tap into the power of factoring.

But what is the difference between factoring and bank loans? And are we always the right decision?

Factoring versus bank loans

You probably already have an idea of ​​how bank loans work. In a traditional environment, a company or an individual will borrow money from a credit institution. Over time, the business or individual will work to pay off this loan with interest. Depending on the structure of the loan, payments may be due monthly, starting now, or all principal and interest will be due at a specific date in the future.

Invoice factoring, on the other hand, relies on your existing invoices as a kind of collateral. If you have an invoice that a customer is responsible for paying, you can sell that invoice to a third party for a discount. You will receive an immediate injection of cash and your customer will pay the invoice directly to the third party.

Advantages of factoring

Factoring has several advantages, especially over bank loans.

First, there is no incursion of debt or compound interest. Invoice factoring is not a loan, strictly speaking. Instead, you’ll be selling your invoices to a third party for cash right away. So your business won’t incur any debt and you won’t owe any compound interest. The downside here is that you’ll sell your invoices at a discount – in other words, you’ll collect less money than you were originally owed. But you won’t have debts or interest hanging over your head.

It’s also a quick and easy approval process. Depending on the institution and the terms of the loan, even a small loan can take weeks or even months to be approved. In contrast, invoice factoring usually involves a much faster and simplified approval process. With that in mind, you’ll likely be able to capitalize on quick funding. Most invoice factoring institutions make it a point to ensure that their clients are funded within a day or two of approval.

In addition, reliability is to the customer’s credit. Banks want to protect themselves financially, so it’s understandable that they only lend to businesses and individuals with high credit ratings. But with invoice factoring, your credit isn’t an issue; your customers are the ones who pay the money back, so financing depends on their credit.

Finally, there is no strict upper limit. With conventional bank loans and lines of credit, you can leverage the maximum amount of capital. But with invoice factoring, you can continue to make more money as long as you have invoices to sell.

Advantages of bank loans

Although there are many viable alternatives to bank loans these days, bank loans are still a powerful and beneficial financial tool for startups.

First, there is a lack of dependence on invoices. The biggest weakness of invoice factoring is that it relies entirely on your company’s current invoices. If you don’t have a reliable clientele or need more money than the total of all your outstanding bills, bank financing may be your only option.

Moreover, there are a multitude of options. There is no single description of a “bank loan”, as the bank can lend you money in different ways. If you shop around with different lending institutions and are willing to negotiate a bit, you can often find a great interest rate, awesome terms, and an overall loan structure that meets your exact needs. You are not locked into just one type of business loan.

Finally, there is flexible repayment. With invoice factoring, you won’t repay the loan at all, since your customers will repay your factoring. But in the realm of conventional loans, you will generally have access to flexible repayment plans. For example, with a floating line of credit, you can often make payments gradually as you see fit.

So, is invoice factoring better than bank loans? In some ways, yes. If you have standing invoices that aren’t yet paid, if your business doesn’t have the credit to take out a conventional bank loan, or if you need quick financing, invoice factoring is the clear winner of the face-to-face. head comparison. However, there are still many situations where bank loans are your best or only option.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.

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