Modern businesses have access to many tools for managing cash flow and funding daily operations. If you are a regular customer of ours, you are already familiar with invoice factoring. There is another tool that is often confused with factoring despite being distinctly different. It is known as supply chain financing (SCF).
It is not unusual for people who don’t know a lot about either tool to confuse them. Unfortunately, some use the names of the two tools interchangeably. We want to clear up any potential confusion that might exist among our customers, which is the point of this post.
A Brief Description of Both
Invoice factoring is a pretty simple tool to understand. Businesses sell their invoices to factoring companies in order to raise cash. When those invoices are ultimately paid, money goes to the factoring company. The company charges a fee to cover its costs. The fee can be a flat fee or a percentage of the invoice.
SCF is a tool through which companies can pay their suppliers early by utilizing some sort of third-party financing. The supplier benefits by getting paid in advance of when its invoices are actually due. The business benefits in two ways: discounted invoice pricing and more time to pay what is owed.
Who Initiates the Transactions
Perhaps the biggest difference between invoice factoring and SCF is the party that initiates the transaction. For the purposes of explaining this particular concept, we will use the terms ‘creditor’ and ‘debtor’.
In an invoice factoring scenario, the creditor controls everything. The creditor initiates the transaction by agreeing to sell invoices to a factoring company. In addition, the factoring company’s terms ultimately determine how much the creditor will pay for the opportunity to get cash.
By contrast, an SCF transaction is initiated by the debtor. For this reason, SCF is sometimes referred to as ‘reverse factoring’. The debtor contacts a factoring company or private lender to arrange financing that is ultimately used to pay invoices early, usually at a discount. The debtor then repays the factoring company or lender.
Both Involve Fees
While invoice factoring and SCF are forms of business lending, neither one is considered traditional lending. Neither service is based on lengthy terms and interest payments. Rather, factoring companies and private lenders earn their money on fees. They charge a fee for the service they provide rather than lending money on interest.
It is impossible to say exactly what fees you would pay for either service. Service providers have their own fee structures based on their individual business models. As such, there is no harm in shopping around.
Factoring Is Better for Creditors
Finally, we get to the question of whether either tool is better than the other. Both have different goals for different parties. As a creditor, factoring is the better option. Why? Because factoring ensures that the creditor remains in control.
Remember that debtors initiate SCF transactions. If you wanted to utilize SCF, you would have to wait until one of your customers offered you that opportunity. But with invoice factoring, you can initiate a transaction whenever it is best for your company. You and your factoring company work out an acceptable agreement between the two of you. Your customers are left out of the equation until it comes time for them to pay their invoices.
In short, invoice factoring and SCF are not the same thing. They do have similarities, but they are initiated by different parties for distinctly different reasons. If you would like to know more about factoring, reach out to us. We are experts in the field.