Wondering the difference between the types of small business financing? Getting the right financial product for your small business is important. However, entrepreneurs should be careful about which small business financing options they choose.
Some make more sense for your company than others. Small Business Trends talked with Hanna Kassis an expert at Segway Financial about how to differentiate between loans, cash advances and small business factoring.
Though sometimes called an invoice advance loan, the name is incorrect.
“The biggest difference is cash advances and factoring are not loans, although sometimes they’re disguised as loans,” Kassis says. The trick for small business owners is in understanding how to pick the financial product that works to make their situation better. Choosing the wrong path can lead to deeper financial issues if your small business is in some trouble to begin with.
Here’s a chart showing the benefits of the various types of financing depending upon your business needs:
Small Business Deals
Types of Small Business Financing Options
When looking at the options for financing your small businesses, perhaps the most important thing to learn is the difference between loans and advances. How do these two forms of financing compare and which is best for your business.
The Difference Between Loans and Advances
Small Business Loans and FICO
There are some fundamental differences. For example, small business loans report to the credit bureaus about the credit of the business and not the owners. These are generally the way to go when you’re looking to make a long term investment in your business.
A good FICO score is required. All your company assets can be used as collateral and funding usually takes about 3-7 days. Use these when you’re on a stable footing financially and looking to grow or expand. Small business loans are a great way to replace outdated machinery and even build a new wing.
Miss a payment on one of these and it gets reported on your business credit. With the other two types, that kind of slip up gets reported on your personal credit.
Merchant Cash Advances and Small Business Factoring: For a Different Set of Needs
These other products have a different set of requirements. A merchant cash advance is a good product for an emergency financial situation. Factoring is the right tool to match income and expenses. With the merchant cash advance, cash flow history is required but your small business doesn’t need to supply any collateral.
Small business factoring, on the other hand, requires actual invoices and those receivables and invoices are used as collateral. Hence the reason this is sometimes called an invoice advance loan.
Kassis notes another difference between the two products.
“Companies that qualify for factoring are typically B2B under unfavourable terms,” He says. “That delayed payment could be a result of the seller offering it to get business or the vendor offering it because they’re spending enough money they can dictate the terms of the deal.”
Say you’re selling bolts to a manufacturer. They’re buying in volume and keeping you busy, but not paying for terms of 30, 60 or 90 days. Factoring allows you to use an invoice advance loan to help you over temporary cash crunches. Products like the invoice advance loan generally take about 2-5 days to process.
If you send invoices, you have a wider range of options. Those choices are limited for businesses like grocery stores if they accept cash up front.
“Businesses with invoices will qualify for factoring, cash advances or a loan,” Kassis says. “Businesses that don’t invoice can only get a cash advance or a loan.”
So here’s a bit more merchant cash advance info to consider.
Cash advances are the quickest solution to get but you need to be careful when you make a decision to go after one of these. There is no collateral needed here and the time to fund is quick at 1-3 days. However, Kassis is clear small businesses need to take a good look at why they’d need this type of money before they act.
“The cash advance is the catch-all. With about $10,000 a month from any source, you can probably get one of these products.”
Cash Advance Catch-all
However, there’s a big caveat to this catch-all. Kassis explains this is a great product for seasonal businesses and restaurants in tourist areas. Both of these small businesses might need some cash ahead of their busy season. He’s clear, however, a cash advance won’t stop a downward business slide.
“If you’re struggling, a cash advance will put you out of business,” he says.
In conclusion, understand what kind of financing you’re looking for when examining the different options. In particular, know the difference between loans and advances and which is right for your business.
So What About the Invoice Advance Loan?
The invoice advance loan, despite its name, isn’t actually a traditional loan. It’s an advance based on the projected earnings a business expects from its invoices.
This financing option allows businesses to access immediate capital based on their invoice’s value, helping them navigate cash flow challenges without waiting for the typical 30, 60, or 90-day payment terms.
While traditional loans typically rely on creditworthiness and might require collateral, invoice advances focus primarily on the reliability of a company’s clients and the anticipated revenue.
They are especially beneficial for businesses that operate in industries with extended payment cycles, where delays in payment can cripple operations.
However, like all financing options, it’s essential to consider the associated costs and terms. While invoice advances can be quicker and more flexible than traditional loans, they might also come at a higher cost.
Therefore, businesses must assess their immediate liquidity needs against the costs of this financing option.
In essence, the invoice advance loan offers a valuable solution for businesses in need of quick capital. But it’s crucial to be fully aware of its intricacies before diving in. This will ensure that the chosen financing tool aligns with the company’s financial health and long-term goals.
Choosing a Small Business Financing Option
Choosing the right financing option for your small business can feel like navigating a complex maze. With so many choices available, it’s crucial to select one that aligns with your company’s needs, goals, and financial health. Here are five essential considerations to guide your decision:
- Assess Your Financial Health: Before diving into any financing option, evaluate your business’s financial statements. Understand your revenue, expenses, and existing debts. A strong financial standing may allow you more flexibility in terms of loan terms and interest rates.
- Determine the Purpose: Clearly define why you need the financing. Is it for expansion, purchasing inventory, bridging a cash-flow gap, or maybe acquiring new machinery? The purpose will guide you towards the most suitable financing option.
- Understand the Costs: Beyond just the principal amount and interest, delve into all associated costs of the financing option. This includes origination fees, processing charges, potential penalties, and any other hidden costs.
- Flexibility and Terms: Not all financing options have the same repayment terms. Some might require monthly repayments while others might have more flexible schedules. Choose an option that aligns with your projected cash flow to avoid future financial strain.
- Consider the Speed of Funding: In some cases, you might need funds urgently. Options like merchant cash advances or invoice financing can be quicker than traditional bank loans. Determine how fast you need the funds and choose an option that can meet that timeline.
Factoring Photo via Shutterstock
Chart courtesy of InvoiceFinancing.net