As a business grows, chances are it’ll need to borrow money at some point. It could be to invest in equipment, to grow to the next level, or simply to get cash flow in a quiet time.
However, once you start looking at the types of lending that are out there, you may discover you have more options than just getting a conventional business loan. Invoice discounting is another common alternative, although many business owners aren’t overly familiar with it.
So how do these two options compare? This is your guide to how invoice discounting is different to a traditional loan.
Invoice financing is easier to get than traditional loans, particularly for small businesses and startups. It’s cheaper, more flexible and doesn’t involve carrying large liabilities on your balance sheet for long periods of time.
While the point of being in business is (usually) to make money, businesses live and die by their ability to pay for things. There are regular bills like wages, rent and power, necessary purchases like stock and equipment, and all sorts of other overheads.
Without the money coming in to cover these basic expenses, businesses go under. In fact, 82% of businesses that fail do so because of cash flow issues.
It may sound dramatic, but cash flow can be critical to a businesses survival.
Invoice discounting is where a business sells an invoice to a third party – an invoice discounting service. Also known as invoice factoring or invoice financing, the business gets a large portion of the invoice paid out on the sale, and the invoice discounter takes on responsibility for collecting the invoice.
When the customer pays the invoice, the discounting company keeps the difference as a fee.
Read more: Understanding invoice financing for businesses (coming soon)
Invoice discounting is a popular option for businesses that earn money through invoicing because it can effectively reduce the time it takes for invoices to be paid.
It does represent an extra cost, but it means a business is more able to cover its overheads in the period between doing a piece of work and getting paid for it. This period can range from anything between a few days to a few months.
Getting a business loan through a bank isn’t your only option – you can also talk to different types of lenders. However, to make it easier to compare, we’re looking at a bank loan specifically.
A bank loan can take a long time to arrange, often needs to be secured against assets, and incurs interest. In order to approve a business loan, banks typically need you to meet a criteria:
Banks often have a minimum amount they will loan businesses – usually $100,000. It’s typically paid back over 3 to 10 years or more, with interest and fees.
The situation you’re in and the circumstances you’re facing will dictate which is the best option for you. Often it’s easy to figure out which route to take – for example, if a bank declines your loan application – but sometimes it’s less straightforward.
There are a few factors to consider:
How much money do you need? Plainly, invoice discounting will only provide finance for an amount that you’ve invoiced for (less discounting fees). If you need an amount that’s higher than the value of your invoices, this option won’t cover it all.
However, it can mean you don’t have to borrow as much, which may make it easier to get a loan, and will definitely make borrowing cheaper.
How much can you afford? Interest rates and regular admin fees make a traditional loan expensive. Invoice discounting rates do vary, but it’s worth comparing the cost of borrowing.
One thing that makes invoice discounting cheaper is the fact that it’s repaid much faster than a traditional loan. With FundTap, you only borrow what you need, so fees are kept to a minimum.
Can you get a bank loan? Do you, or does your business have the assets to secure a loan against? Do you have a satisfactory credit history? A bank has many requirements that invoice financing companies don’t, making the latter much easier to get.
How soon do you need the money? As mentioned, it can take weeks, or even months, to get a bank loan approved, which won’t help you if you need the money to pay bills that are already due.
Online invoice discounting can be arranged much faster. For example, the invoice discounting process with FundTap means businesses can be approved for financing within a matter of hours, and have funds transferred into your bank account on the same day you apply for finance.
The advantages of invoice discounting are particularly noticeable for small businesses and startups.
As mentioned, banks often have a rigorous criteria for approving business loans, and many new or small businesses simply can’t satisfy lending requirements.
However, invoice funding helps businesses to get borrowing because it’s effectively secured against invoices, which are a reliable form of repayment. It’s also much quicker to get approved for invoice discounting.
Traditional business loans sit on a business’ balance sheet for years as an ongoing liability. This is one way they end up costing more, with interest and fees being applied during that time.
Invoice discounting is repaid as soon as customers pay invoices. The cost of getting the lending is essentially a one-off.
Bank loans come with a set amount for a set term. This rigid structure does not provide the flexibility needed to meet day to day cash flow needs.
If the borrowed amount is higher than you need at any one time, it ends up costing more to get extra money that isn’t needed. If the borrowed amount is too low, you don’t have the cash needed to run your business and you could be in danger of failing.
Invoice discounting is available for any value that you’ve invoiced a customer for. There are no arbitrary limits – it’s all dictated by money that’s already owed to you.
Invoice discounting works extremely well as a supplement to other borrowing. The combination of a term loan to capitalise the consistent finance need with the flexibility invoice discounting provides is often the most effective and efficient financing structure for most businesses.
Invoice discounting companies do charge a portion of invoices, but they do also perform some services so you don’t have to.
For example, they can set credit limits for customers and chase invoices. If you don’t do credit checking, or spend a lot of time chasing late invoice payments, there may be value in taking these tasks off your plate.
In saying that, some businesses may be uncomfortable having a third party communicate with their customers on their behalf. You may prefer to be more discreet about the financing you use, and you may be concerned about how it may impact your customer relationships.
Invoice financing with FundTap has been developed to be an effective funding option for small businesses.
FundTap comes with all of the advantages of invoice discounting, but it stands out from other invoice discounting companies in a few key ways:
On the balance of factors, FundTap is the best platform for invoice discounting that’s quick, convenient and cost effective.
Find out more about how FundTap works, or book a free demo today.