Slow-paying customers are one of the most common cash-flow problems for business-to-business companies. You’ve done the work and sent the invoice, but the money won’t arrive for 30, 60 or 90 days.
Two of the most common fixes are invoice factoring and a business line of credit. They solve the same problem in very different ways, at very different costs.
How each one works
Invoice factoring. You sell unpaid invoices to a factoring company:
- It advances most of the invoice’s value, typically 70%–95%, within a day or two.
- When your customer pays the factor, you receive the rest, minus the factoring fees.
- Approval depends mostly on your customers’ creditworthiness, not yours.
Business line of credit. A lender approves a credit limit you can draw on as needed:
- You pay interest only on the amount you draw.
- You repay and borrow again, much like a credit card but usually at a lower rate.
- Approval depends on your business’s credit, revenue and time in business, and sometimes on collateral or a personal guarantee.
A cost comparison
Suppose you need cash against $50,000 of invoices that your customers pay in 45 days.
Factoring
- The advance rate is 85%, so you receive $42,500 upfront.
- The fee is 3% per 30 days. At 45 days, two fee periods apply, so the fee is $3,000.
- That is an effective annual rate of about 57% on the cash you received.
Line of credit
- You draw $42,500 at 12% APR for 45 days.
- Interest is about $629.
The line of credit is almost five times cheaper in this example. The gap narrows if your line’s rate is higher or your customers pay faster. Run your own terms through the invoice factoring calculator.
Side by side
| Invoice factoring | Business line of credit | |
|---|---|---|
| Typical cost | 1%–5% per 30 days (often 15%–70% effective APR) | Interest on the balance drawn, plus possible fees |
| Speed to first funding | Days | Days to weeks, longer at banks |
| Approval based on | Your customers’ credit | Your business credit, revenue and history |
| Grows with sales | Yes, automatically, as you invoice more | Only if the lender raises your limit |
| Customer involvement | Usually paid directly to the factor | None |
| Debt on your balance sheet | Usually a sale of receivables, not a loan | Yes, it’s a loan |
| Collections help | Often included | No |
| Builds business credit | Not usually | Yes, when reported |
When factoring makes sense
- You’re a young business or have limited credit, but you invoice creditworthy customers such as large companies or government agencies.
- You’re growing fast, and a fixed credit limit can’t keep up with your receivables.
- You need cash in days, and a bank line isn’t available yet.
- You’d value outsourcing collections and credit checks on your customers.
When a line of credit makes sense
- You have two or more years in business, steady revenue and decent credit.
- Your cash gaps are short and predictable, and you want the lowest cost.
- You’d rather your customers not know you’re financing your receivables.
- You want to build business credit for future financing.
Questions to ask a factoring company
- What is the advance rate, and exactly how is the fee charged: per 30 days, per 10 days, or daily?
- Are there minimum volume requirements or monthly minimum fees?
- Is it recourse (you buy back unpaid invoices) or non-recourse, and what exactly does non-recourse cover?
- What other fees apply: application, due diligence, ACH or wire, termination?
- Must you factor all invoices or only the ones you choose (spot factoring)?
- How long is the contract, and what does it cost to leave?
Avoid the most expensive option by accident
If neither factoring nor a line of credit is available, businesses sometimes turn to merchant cash advances. Their factor-rate pricing often works out to triple-digit APRs; see our guide to factor rate vs. APR.
For longer-term needs such as equipment, a term loan secured by the asset is usually cheaper. Compare payments with the equipment loan calculator. Free advice is also available from SBA resource partners such as SCORE and Small Business Development Centers.
Sources:
- U.S. Small Business Administration: loan programs
- SBA: manage your finances
- CFPB: small business lending