Introduction to Factoring & Invoice Financing for Your Digital Lending Operation

Running a small business is hard enough as is. But the reality we live in is such that in addition to the challenges of finding customers, paying rent, controlling quality and delivery of goods or services, one has to deal with the fact that more or less 60% of invoices are paid late. The idea behind factoring and invoice financing is to give a helping hand to businesses that struggle with this issue.

Late payments leave business on the ropes struggling to cover the ongoing expenses. This means that ventures dealing with construction, manufacturing, wholesales, logistics, recruitment, etc are often victims to their own customers. And those customers might not even mean harm. They might need to resell the goods or free up the capital to cover their expenses. There’s no way to prevent all the payment delays from happening altogether. But any payment delay endangers the performance and even existence of a business on the other side of the deal.

Past due invoice payments aren’t a new concept. Even in 1400 England, the merchants were using the mechanisms preceding modern invoice financing and factoring to ensure their day-to-day expenses are covered and they can safely wait till they receive the full payments for the goods they sold or services they provided. After all, even then it was a really simple question: you either sell the depts people owe you to someone else and lose a bit of money in the form of fees or you close shop since you depend on the money which you can’t get on time.

For a very long time, invoice financing and factoring have been a beneficial tool both for the lenders and for the SMEs. And in today’s digital environment things aren’t that different. On the contrary, it takes a lot less effort and risks to sell, buy, and operate this kind of credit products. But if you’re about to get into the business of buying and collecting businesses’ outstanding debts, you need to make an informed decision as to which model you’ll use: invoice financing or factoring. Cause even though they share some similarities, the devil is in the details.

Intro to factoring for a digital lender

The names factoring goes by include invoice factoring, accounts receivable factoring, and accounts receivable financing. This form of lending means that you, as a credit provider, will take care of the sales ledger of the merchant and will be fully responsible for getting customers to pay the amounts stated in their invoices.

It’s the better scenario for the merchant but a more complex one for the lender since it involves taking care of a bigger chunk of paperwork and bureaucracy as well as the full responsibility of dealing with the debtors. Basically what happens is that the lender pays about 80% of the price of the account receivables to a business and then goes on to collect the money from the business’ clients. Even though the business owner’s expenses grow as they have to pay the percentage of the debt to the lender, they get to quickly balance their books with the influx from the purchased invoices.

Usually, the lender purchases invoices in two installments. The advance payment most commonly is 80% and as soon as the invoice is paid in full, the remaining 20% is wired. Of course, minus the percentage and the fees which the lender keeps. In most cases, the client pays the debt within 30-60 after the due date and that is when the dealings on each particular invoice are completed. Alternatively, if the lender and the business cooperate on a permanent basis, second installment (rebate) can be paid to the business in weekly, bi-weekly, or monthly batches.

Intro to invoice financing for a digital lender

With invoice financing, the deal is slightly different and a bit more adjusted towards the lender. This is compensated by smaller interest and fee. In a nutshell, the lender provides business with a short-term loan where the invoices serve as the collateral. As soon as the client pays back their debt, the loan has to be returned + fees and interest. Here the business owner also usually gets more money upfront from the lender.

There are several ways to organize money transfers when it comes to invoice financing. The business owner may receive the money directly and then repay the loan with fees and interest. Or the lender may be injected into the system to receive the funds from the accounts without the additional transactions.

It’s an easier deal for the lender since it’s the business owner who has to take care of the collection of the debts and all the communication with their clients. And some might say that it’s better for the merchant too since their clients aren’t intimidated by the fact that some third-party company is trying to collect their debts. At the same time, depending on the business niche, this may increase the risks of non-repayment, since not many SMEs have proper debt collection practices in place. But if the paperwork of the contracts and the invoices is solid, in most cases the collection of funds is just a matter of time.

Factoring vs invoice financing: Which to choose for your digital lending operation

To recap, the key difference between the two is as follows:

With factoring, lender purchases and owns the account receivables with debts. With invoice financing, these receivables are collateral of the loan which the lender provides. And even though the two approaches aren’t the same in this crucial way, in some markets, like UK’s, they are considered to be a part of the same concept. The factors to take into consideration when structuring your lending business include:

• Advance the lender has to provide

Invoice financing: 80%

Factoring: 80-90%

• Lender’s fee

Invoice financing: 1-3% per month

Factoring 2-4.5% per month

• Invoice collection

Invoice financing: business

Factoring: lender

• Invoice ownership

Invoice financing: business

Factoring: lender

Overall, the choice is pretty straightforward. If you have the resources and the expertise that will help you collect the debts efficiently and quickly – factoring will result in higher rates and interests. And if it’s preferable for you to simply act as a provider of funds and let the business owner take care of the day-to-day hassle with their clients, invoice financing can be a steady source of income. In addition, both models can coexist within one organization and conditions can differ depending on each customer’s niche and reliability. So in order to play it safer, a lender may start with invoice financing and once they are comfortable with this crediting model, they may branch out and experiment with factoring to reap bigger returns. It’s important to keep in mind that in many jurisdictions, regulations may differ for the two models, so make sure to consult with qualified local legal counsel prior to making any serious steps.

Learn more about AML & KYC for a digital lending business. 

What to expect from your factoring & invoice financing software 

• Different funding models

Marketplace: With this model, a lender can choose which invoices to fund and which to ignore, depending on the risks calculated by the lending software, the returns, and the potential customer in question.

Financing program: Here a lender can set up a program of steady funding of invoices from a chosen business. This way a business can find an announced program and apply to either be approved or rejected.  

Funding by rules: This model lets the lender specify a list of conditions (like industry, risks, amount, and term) at which they are ready to finance invoices. And if a business complies, it can get funded automatically.

• Integrated factoring/invoice financing automation

You should be able to put both invoice financing and factoring on autopilot by setting the conditions and caps at which you are willing to fund invoices. Lending, no matter the model, includes a ton of workflows, elements, and crucial details. This work can either be done manually by a bloated staff or large chunks can be fully automated increasing the returns, minimizing human error, and increasing the speed of your operation.

• Intelligent risk evaluation and scoring 

As with any other lending business, borrower evaluation is a critical part of the process which determines the safety and growth potential of the venture. The self-learning deep neural networks behind TurnKey Lender’s origination engine use both traditional and alternative approaches and data sources to evaluate the businesses that will opt to get funded by you and will show you the risks. This helps you make sure you set the interest rate accordingly or decline the applications that don’t meet your criteria.

• Smart workflows

Invoice financing and factoring are among the more intricate credit products. TurnKey Lender’s team has tailored separate versions of its all-in-one system to meet the specific needs of both lenders and borrowers who are looking for this kind of solution.

• Ease of deployment and use

TurnKey Lender’s solutions both for invoice financing and factoring can be completely white-labeled in accordance with your company’s branding and deployed within days. In addition, the system is built with the latest design best practices in mind, so there is virtually no learning curve neither for the lender’s staff nor for the businesses it will be working with.

• Modular nature and wholesome functionality

In the world of software platforms, few things are more annoying and damaging to productivity than situations where different departments operate in different tools which syncronize poorly if at all. TurnKey Lender offers a modular platform which allows lenders to choose which parts of their process they’d like to improve and automate. All the elements of the system are finetuned to communicate with each other and provide you and your employees with a seamless experience.

Book an intro call

Buying a pig in a poke is unacceptable when it comes to choosing software to power your whole business. Having worked with financial businesses for decades, at TurnKey Lender we understand this better than most. That is why we offer a free trial and demos of our platform to lenders. So if you’re still undecided, do opt in for the trial, check out all the benefits yourself, and make an informed decision.

Learn more about TurnKey Lender Factoring & Invoice Financing platform and book a demo today.