As a small or medium-sized business (SMB) owner, you understand the significance of working capital for your business's daily operations. When you've supplied goods or offered services to your clients and they haven't paid you for several days, weeks or months, the delays create a shortfall in your working capital, which can hinder your business operations.
However, you can use debt collectors to claim these payments from your clients or factor your invoices to get the cash you need to run your business. Although sometimes used interchangeably, debt collection and invoice factoring are different ways of getting cash for your business when you have pending receivables or expect payments from your clients.
What Is Debt Collection?
Debt collection is when a company makes an effort to collect payments that are at least 30 days past the due date. The company or agency doing the debt collection is known as a debt collector and they're paid a certain percentage or a flat fee for their collection services. As a business owner, you'll hire a debt collector to collect payments from your clients on your behalf.
Your clients who owe you payments shouldn't experience any form of harassment or threats when they're contacted by your debt collector. Individuals who feel harassed by debt collectors can file a complaint with the Federal Trade Commission (FTC), Consumer Financial Protection Bureau or any state's attorney general. Therefore, you should always aim to use reputable debt collection companies like BCA that follow the rules and regulations of debt collection.
You should also be aware of your state's statute of limitations on debt. The limitation is the duration the debt collector has if they wish to sue the borrower to collect a debt. Although the statutes of limitations vary from state to state, they often last from three to six years. The borrower still owes you even after the expiry of the statutes of limitation and your debt collector can use other means to collect the payments.
What Is Invoice Factoring?
Invoice factoring is when a business sells its outstanding invoices to a factoring firm for immediate cash. You transfer ownership of your invoices to the factoring company in exchange for cash. The cash is calculated as a percentage of the invoice amount. Only businesses that create invoices for their buyers are eligible for invoice factoring.
Factoring firms typically charge a percentage of the invoice amount for their services, plus additional fees that may include origination fees, monthly minimum fees and service fees, among others. The factoring fees are based on the invoice amount, your customer's creditworthiness and your sales volume. The fee will also depend on whether you have a recourse or non-recourse factoring agreement.
You will be held responsible for the debts of invoices your customers fail to pay if you have a recourse factoring agreement. If you have a non-recourse agreement, the factoring company will assume most of the risks associated with nonpayment.
Differences Between Debt Collection and Invoice Factoring
Some of the major differences between debt collection and invoice factoring include:
- The purpose for funding: You'd use a debt collector and an invoice factoring firm for different reasons. You sell your current unpaid invoices that can be no more than 30 days old when you use the invoice factoring option. Debt collection deals with invoices that are at least 30 days past the due date.
- Funding timeline: This is the amount of time you're willing to wait before receiving payments. It will depend on what your cash flow looks like. For debt collection, you receive payment after your client pays the collection agency. Invoice factoring allows you to receive instant money against your invoices.
- The process: The debt collection and invoice factoring processes are different. A factoring company first conducts due diligence to determine whether customers are creditworthy. Once they've verified and validated the clients' creditworthiness, the factoring firm funds the business immediately. The debt collection process consists of written correspondence between the customers and the collector, including reminders to retrieve the debt owed.
How Are They Similar?
Both debt collection and invoice factoring are sources of business financing. They are solutions to one of the major obstacles in running businesses — low or constrained cashflows. Both debt collection and invoice factoring allow businesses to finance their operations without following up with their customers' debt payments. They will both ensure your invoices get paid by communicating with your customers and offering them various payment options.
Your business and personal credit score are not considered when you want to use either a debt collection company or an invoice factoring firm. This makes both financing options ideal for startups, small businesses and medium-sized businesses without a solid financial footprint.
Some debt collectors offer to purchase your debt at a fraction of its face value and later attempt to recover the full amount from your customers. In such cases, you will get payment within a short time, making this option almost similar to invoice factoring.
Debt collection companies and invoice factoring companies operate within specific regulations. These regulations provide restrictions on what these companies can do. For example, the Fair Debt Collection Practices (FDPA) limits what debt collectors can do when attempting to collect specific types of debt.
However, there are no laws that regulate the invoice factoring industry in the United States — and there is no formal government body that regulates the industry. Instead, invoice factoring companies have formed associations like The International Factoring Association, where they self-regulate.
How Do I Know Which Type Is Right for My Business?
If your business runs out of cash and you need to restock or pay urgent bills, which is the best financing option? Choosing invoice factoring or debt collection will depend on various factors, such as the risks that you're willing to take as you seek financing. Review the differences and similarities we've highlighted, and you'll be able to narrow down to the specific option that suits your business.
Managing client relationships can be a challenge when they fail to pay invoices that are due, which is why you may opt to use a third party to collect the money on your behalf. These debt collectors should not harass your customers because they operate within specific federal laws and regulations. Although factoring companies may give you instant cash, there is no formal government body or laws that regulate their operations.
Contact BCA for Debt Collection Services
Business Consumer Alliance undertakes to collect debts on your behalf so that you can concentrate on running your business with peace of mind. Outsourcing debt collection services to BCA saves you time and money by avoiding litigation, and your business receives the much-needed cash flow to continue operations. Become a BCA member to get these collection services and access exclusive benefits. You can deduct your annual BCA membership fees to reduce your taxes.