It's not unusual for SMEs to reach a point early in the startup stage or as they gain traction, where they experience cash flow problems. Often caused by fast growth, financing can quickly solve cash flow problems.
However, obtaining business financing can be a daunting ordeal for business owners. With various solutions, each with its pros and cons, it's hard to decide the right choice for your business.
This article discusses two alternatives to cash flow issues; invoice factoring and line of credit. They offer almost similar advantages but can pose disparate impacts on your business's financial future. Read on to compare the two and know which is better for your business.
What is Invoice Factoring?
Invoice factoring entails borrowing against slow-paying receivables. The factoring company advances cash against the value of your open invoice in exchange for the right to collect against it. The factoring company makes the payments in two installments; 85% once it receives the invoice and 15% once your client pays the invoice in full.
Pros
Easy to process and set up
It simplifies the time-consuming and challenging task of collecting receivables.
Eliminates the issue of debt for your business
Let you take advantage of business opportunities on a timely basis.
Cons
The amount available to your business once you factor in an invoice is directly tied to the amount owed to the outstanding invoice.
Your business's credit rating and that of the client who submits the invoice for factoring influence the charging rate.
Your fee increases as long as an invoice remains outstanding.
What is a Line of Credit?
Line of credit is a concept widely known and yet generally misunderstood. A line of credit is an institution, usually a bank, which provides you with funds up to a certain amount referred to as the credit limit. While drawing funds from the line reduces your available funds, paying back the line increases the funds available. As long as you make payments, your business can keep drawing against the line.
Pros
When interest rates are low, lines on bank credit lines reduce as well.
A line of credit solidifies your partnership with your bank, with prompt payments enhancing your business's credit standing.
A credit line's accessibility gives your business almost immediate access to funds as needed.
Cons
Tricky to obtain depending on financial conditions and the commercial lending climate
The bank may impose changes on matters on your credit line as they wish
Bank lines of credit may turn very expensive even during a low-interest rate climate.
A bank line of credit automatically accrues debt to your business's balance sheet.
Differences between Invoice Factoring and a Line of Credit
Ease of setup
The factoring setup process is relatively easy if the invoice and your client qualify financially for invoice factoring. To obtain a line of credit, the institution offering it must financially review your business, which could take days or weeks.
Communication with your client
The factoring company takes over your invoice and all communications with your client regarding payment. With a line of credit, your client isn't involved in the communication at all.
Cash availability
Factoring dictates that you don't get paid until you've invoiced your client, which forces you to source cash from elsewhere to start your project. You can access a line of credit any time once you establish it.
Credit Limit
With a line of credit from whichever institution, the credit you qualify for depends on your business's credit history and financial statements. For factoring, the credit limit depends on the number of your accounts receivable.
Bottom Line
While the ultimate financing choice for your business is yours to make, the easier and more readily available option is invoice factoring.
Crown Financial is in the business of invoice factoring. Contact us to learn more about our invoice factoring packages.