Trade Credit
17.3.2023

Digital trade credit vs invoice factoring

Hokodo

Sometimes, once we’ve explained to someone what Hokodo does, we get asked the question “Isn’t that just invoice factoring?” The short answer is “No.” The long answer is in the blog post below.

What is invoice factoring?

Invoice factoring is a type of financing whereby a business sells some or all of its invoices to a third party in an effort to improve cash flow and unlock working capital. 

The factoring company will pay the business up front for between 80% and 90% of the invoice value, and then take responsibility for collecting payment directly from customers. 

It’s sometimes known as invoice financing, accounts receivable factoring or debt financing.

How does invoice factoring work?

  1. You sell goods or services to a customer as normal.
  2. Once the order is complete, you invoice the customer. They expect payment terms of 30, 60 or 90 days.
  3. Then, you sell the invoice to the factoring company. You receive immediate payment of up to 90% of the value of the invoice from the factoring company.
  4. Once the customer’s payment due date arrives, the factoring company is responsible for collection and chasing debt if necessary.
  5. Once they have been paid, the factoring company pays you the remainder of the invoice value, minus their fees.

When should you use invoice factoring?

If your business often has many invoices outstanding or you are suffering from cash flow issues, invoice factoring might help.

Many businesses offer customers 30-day payment terms, which means that the majority of your working capital is tied up for a month or more after the initial purchase. Invoice factoring allows you to access that money from the date of invoice, which you could then use to:

  • Invest in growth
  • Hire new staff
  • Pay your employees

However, there are some significant risks and disadvantages to be aware of when considering invoice factoring as an option.

  • Most factoring companies will demand that most or all invoices are sold to them – even those from your customers with a reliable payment record. They might also try to tie you into a long-term contract.
  • If a customer fails to pay, you may be contractually obliged to repay the factoring company for the amount they’ve already paid to you. This is where invoice insurance comes in.
  • Even though factoring can stabilise your cash flow and help you to grow, it can be perceived by customers as a signal that your business is not doing well. 
  • Factoring companies may pursue debts in a way that alienates or angers your customers, which could harm your reputation and revenue.

What is digital trade credit?

Digital trade credit is a newer B2B payment solution that makes it easier and safer for businesses to buy and sell on payment terms online. It’s a form of short term financing that enables customers to defer payment while sellers receive full payment up front.

It’s similar to factoring in that it helps businesses to improve cash flow and unlock working capital, but it provides more value and flexibility than traditional factoring.

Usually, businesses work with specialist providers to offer digital trade credit to customers.

How does digital trade credit work?

  1. You sell goods or services to a customer as normal.
  2. When the customer reaches the checkout, they’re offered a tailored credit limit and payment terms.
  3. The customer chooses their preferred terms and checks out. 
  4. When the order is delivered or the service is complete, the digital trade credit provider pays you the full value of the invoice, minus their fees.
  5. Once the customer’s payment due date arrives, the digital trade credit provider is responsible for collection and chasing debt if necessary. Risk protection means that you keep the full value of the invoice, even if the buyer is unable or unwilling to pay.

When should you use digital trade credit?

Like with invoice factoring, digital trade credit can be useful for businesses who are suffering from cash flow issues because they sell on payment terms. It allows you to access more of your working capital so that you can spend that money wherever it’s needed, whether that’s wages, growth or paying your own suppliers.

However, digital trade credit doesn’t carry the risks and disadvantages associated with traditional factoring.

  • Digital trade credit providers can process all of your transactions, but equally can sit alongside other payment methods in your checkout. Providers won’t tie you into lengthy contracts.
  • If a customer fails to pay, risk protection from your digital trade credit provider means that you get to keep the full value of the invoice.
  • It’s not uncommon for suppliers to partner with payments providers and processors, so a relationship with a digital trade credit provider won’t have any negative connotations for your customers.
  • High quality providers will pursue debt with tact and respect in order to preserve your commercial relationships.

Furthermore, digital trade credit adds far more value than selling invoices to a factoring company ever could. Businesses can outsource the entire order-to-cash cycle to their digital trade credit provider, who will take responsibility for credit checks, fraud assessments, payment processing, financing, insurance and collections.

The results speak for themselves. When customers are offered trade credit at the checkout, average order value jumps by 30% and purchase frequency grows by 24%. Merchants report conversion rate increases of 40% after implementing a digital trade credit solution.

Find out more

Download our digital trade credit infographic to find out more about how it could work for your business.

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