We often talk to businesses that are confused about the differences between a fee funding service and invoice factoring. Although they sound like they might be similar, once you dive into the detail, it’s clear they are very different services with varying ideal business use scenarios.
Did you want to get paid 100% of your invoiced fee upfront, while your client takes their time making smaller monthly payments? Let’s understand which service will deliver you this.
How does fee funding work?
smartAR’s Fee Funding product provides professional services firms with a simple way to offer their clients flexible monthly payments, rather than needing to pay a one-off lump sum. It’s another payment option, so your clients have more choice about how they pay.
The obvious benefits for your clients choosing to use fee funding are:
- Flexibility: they can choose the amount they want to pay and the period they would like to spread their payments over
- Low cost: interest or fees are a tax-deductible business expense
- Simple: to set up is a seamless and paperless online process
- Fast: same day approval with no credit checks or financial statements needed
And what about the benefits for your firm? Again, there are many reasons why you would want to offer fee funding to your clients:
- No cost: offering your clients fee funding won’t cost you a cent
- Cash flow: you receive 100% of the amount you invoice, upfront and in full
- Payment flexibility: providing your clients better service with multiple payment options. Your clients can spread their bills over 3 – 18 months, for bills between $550 and$150,000.
- Fewer hassles: no more time spent checking and chasing after your slow payers
- Less risk: you won’t be charged for any unpaid interest or incur any penalties for non-payers.
A major benefit of Fee Funding is that your clients agree they want to pay using the spread payment service.
Want more information? Check out our fee funding page for details.
How does factoring work?
Factoring, invoice financing, invoice discounting or accounts receivable financing all refer to the practice of selling your overdue invoices to a third party. You are paid a percentage of the total invoice amount after a deduction to cover the factors’ commission and fees. Often the third party will also chase your overdue debtors on either a “disclosed” or “undisclosed” basis. Invoice factoring can improve your immediate cash flow problem by providing a cash injection, but you will never recover the full invoice amount.
There are a few catches with factoring. Unlike fee funding the debtors that need to pay the invoices still only have the option to pay as a lump sum. Also, the fees charged by the “factor” (company taking over the debt) may depend on the credit worthiness of both your business and your slow payers.
The key benefits of invoice factoring for your business include:
- Fast cash – access working capital quickly to cover a shortfall in cash reserves
- Improved cash flow – continue to keep loyal customers on generous payment terms but let cash flow issues stop you from business growth
- Simple approval – invoice factoring approvals can be simpler to navigate than more traditional bank loans. Typically, factoring companies are looking at the value of your invoices and the creditworthiness of those clients.
- No security – invoice factoring is generally “unsecured financing” – at least no security other than the security of the debtors themselves.You may however be required to repurchase an invoice that does not pay within a certain number of days.
The key risks of invoice factoring for your business include:
- High cost – accessing invoice factoring can be very expensive. You should be aware of all fees, commissions, application and processing fees before you commit to the service. Be aware that late payments by your clients can trigger an increase in the annual cost of borrowing money under your invoice factoring arrangement
- Poor Customer Service – check how the factor will approach unpaid invoices with your clients. They can be abrupt and aggressive since ultimately they may require you to repurchase the invoice. Make sure they act ethically and fairly.
- Your client’s credit worthiness – the factor is likely to check the creditworthiness of your customers and they may not get approved for financing. The factor expects to be repaid like any other finance company.
- Repurchase Guarantees – if the factor can’t get your clients to pay up, the factor may require you to buy back the unpaid invoice, or replace it with another invoice of equal or greater value.
A major objection to factoring is that your clients’ debts are being sold but they have no say in the introduction of a third party to the relationship. For this reason, many businesses are cautious about using factoring to generate quick cash flow.
In summary, if you are a professional service business (eg Lawyer/Accountant/Recruitment etc) factoring your invoices should only be used as an emergency short term solution to generate cash. Factoring is not recommended for those industry sectors.
If however, you are from another industry sector then factoring may help you out. An example might be the advertising industry. There is often a long “cash conversion cycle” between purchase and payment. If you have a need for cash before a payment due date and your clients enjoy good credit records, then factoring helps bridge this gap.
Fee funding is structured and positioned differently to factoring.
smartAR clients tell us that when they offer smartAR Fee Funding to all their clients as an additional payment option, even clients with very good payment histories will take up the opportunity to fee fund. On top of that, by choosing smartAR Fee Funding, you’ll definitely get paid 100% of the invoice upfront.
At the end of the day, providing your clients with flexibility when it comes to making payments can improve your customer service and cash flow. Clients love choice and options, particularly when they don’t have to ask you for it!
Wanting to improve your customer service and business cash flow? Check out smartAR’s Fee Funding solution to support your business and client needs.