Receivables Financing vs Factoring: Which is Best for Your Company?
For any business to be a successful endeavor, it needs a consistent cash flow stream. Whether you’re looking for money to get through a dry period or hoping to expand your company, it’s critical to have access to funds.
Business owners who need financing have many options available, but many companies will end up weighing the pros and cons between receivables financing vs factoring.
When it comes to factoring vs discounting receivables, financiers draft these agreements in multiple ways. While both funding types use accounts receivable as collateral, the financing can be structured as an asset sale (factoring) or a loan (accounts receivable securitization). Many people use the terms accounts receivable securitization vs factoring interchangeably. However, they are very different. Account receivable financing is generally more akin to asset-based lending in its execution.
In this article, we will further explain the difference between factoring and accounts receivable financing, as well as their difference from traditional loans. Soon, you’ll be able to determine which type of funding is most suitable for your business.
Accounts Receivable Financing
Invoice factoring accounts receivable financing shares similar characteristics with a traditional bank loan, as they both use collateral to provide funds. However, you should be aware of a few significant differences before applying for financing.
A traditional bank loan extends businesses a line of credit or provides funding by using the company’s assets, such as equipment or property.
With accounts receivable financing, a lender provides funding when a business pledges its assets derived from its accounts receivables. These assets have extrinsic value — the sum of any outstanding balances that have been billed to clients yet have not been paid in full. However, since the business does not have access to funds from these outstanding invoices, they may need a loan as an advance.
In the most common accounts receivable financing arrangements, the borrower receives financing capital related to a portion (typically up to 75 percent to 85 percent) of their accounts receivable.
In an accounts receivable loan agreement, the company is given an advance on its accounts receivable balances but does not sell its assets. Depending on the terms, your agreement can use unsecured or secured invoices as collateral. Either way, accounts receivable financing is treated as a standard loan in terms of repayment.
While it may seem like an easy route to obtaining funding, most financiers will not accept an invoice over 90 days old or will not give funding if the business’s creditworthiness is questionable.
Factoring
Accounts receivable financing factoring has similar traits to standard accounts receivable financing. While both issue a line of credit or a lump sum for a business to meet its immediate funding needs, factoring accounts payable involves the purchase of the company’s outstanding accounts receivable by a financial company (called a factor).
A factoring arrangement will typically see the business receive an advance of 70 percent to 90 percent of a selected accounts receivable invoice. Once the lender collects the payment in full, the remainder of the invoice (minus the factoring fee) will then be released to the company.
The factoring fee is a notable difference when comparing receivables financing vs factoring. This fee is based on the total face value of the debtors’ invoices and varies between 1.5 percent to 5.5 percent. The fee percentage is dependent on aspects surrounding the advance, such as how likely the original debtor is to pay.
Accounts receivable financing factoring arrangements do have benefits for the company, such as the ability to select which invoices it chooses to sell. After the company determines which invoices it will sell, the factor takes over the management and bookkeeping of the asset.
Receivable Financing vs Factoring
As you can see, there are many similarities between receivables financing and factoring. However, the core difference between receivables financing vs factoring lies in the final ownership of the invoices.
Through receivables financing, your company still owns the invoices after you have repaid the loan. While this may seem advantageous since you retain rights, you will receive less upfront capital for the value of your asset. Financiers that are issuing out loans with invoices as collateral are also more likely to have stringent prerequisites. An invoice must meet a prescribed standard before being considered a valid form of collateral.
A factor will also go through a business’s invoices but is typically more relaxed about the condition of the asset. However, if the company’s client (the debtee) isn’t held to reasonable terms of repayment or if they are inconsistent with their payment, the factor may mark that particular invoice as falling within an acceptable range to use as collateral.
Receivables Financing vs Factoring: Which is Best for You?
Choosing between funding requires careful consideration, as each will have a different effect on your company.
While receivable financing leaves business ownership in your hands, it is a loan and is counted as debt. If you need to seek further funding through traditional means, this may be an obstacle.
In terms of factoring, even though you’re relinquishing your accounts receivable books to a factor, it becomes the factor’s responsibility to collect the debt. Therefore, the transaction doesn’t impact your debt-to-equity ratio. If you only need to secure a line of credit to hold your company over a rough patch, this may be the most fruitful avenue.
L3 Funding Can Help
While there are several aspects to reconcile when comparing receivables financing vs factoring, finding which is the right fit for your company can be difficult. If you would like to learn more about merchant funding or a secured business line of credit, contact L3 Funding.