Invoice/Accounts-Receivable Factoring vs. Financing
What is the Difference between Receivable Financing vs Factoring
The primary difference between factoring and bank financing with accounts receivables involves the ownership
of the invoices. Factors actually buy your invoices at a discounted rate, while banks require you to pledge or
assign the invoices as collateral for a loan.
Lei Li
May 9, 2022
May 9, 2022
As a business owner, you probably heard about invoice factoring and invoice/accounts receivable numerous
times. On many occasions, they are perhaps used interchangeably by both business owners and
financiers. Although both invoice financing
(accounts receivable) and factoring can be used to access funds quickly for working capital, however, they
are not the same thing. Banks do not normally offer true accounts receivable factoring since they do not
buy the invoices. They use them as collateral for a loan. Here are the key differences between
the two accounts receivable methods.
Factors Buy, Banks Loan
Similar to a factoring company, the bank analyzes your existing accounts receivable and chooses the ones they will accept as collateral. If they do not like the customer’s terms of repayment or if the customer pays too slowly, they will not count those accounts receivables as collateral. The factor also examines your accounts receivables and is normally more lenient on the ones they accept, but they will typically charge slightly higher fees on the invoice payments that come in late. Also, since the factoring is not considered a loan, it will not affect your debt utilization or debt-to-equity ratio. Obviously, the bank loan will and this can have negative repercussions depending on your current debt situation.
Factors Pay 97% to 99%, Banks Loan Only 75% to 85%
The factor will advance you around 75% to 95% on the invoices they factor and hold the other 25% to 5% in reserve. The factor pays you back the reserve as your customers pay their invoices. Typically, you end up with 97% to 99% of your total accounts receivables after all payments are collected and the 1% to 3% factoring fee is taken out. Most banks only loan you 75% to 85% of the value of your invoices and they charge you an interest rate on the amount of the loan. This rate is usually higher than other types of traditional business bank loans.
Similar to a factoring company, the bank analyzes your existing accounts receivable and chooses the ones they will accept as collateral. If they do not like the customer’s terms of repayment or if the customer pays too slowly, they will not count those accounts receivables as collateral. The factor also examines your accounts receivables and is normally more lenient on the ones they accept, but they will typically charge slightly higher fees on the invoice payments that come in late. Also, since the factoring is not considered a loan, it will not affect your debt utilization or debt-to-equity ratio. Obviously, the bank loan will and this can have negative repercussions depending on your current debt situation.
Factors Pay 97% to 99%, Banks Loan Only 75% to 85%
The factor will advance you around 75% to 95% on the invoices they factor and hold the other 25% to 5% in reserve. The factor pays you back the reserve as your customers pay their invoices. Typically, you end up with 97% to 99% of your total accounts receivables after all payments are collected and the 1% to 3% factoring fee is taken out. Most banks only loan you 75% to 85% of the value of your invoices and they charge you an interest rate on the amount of the loan. This rate is usually higher than other types of traditional business bank loans.
Factors Can Take on the Responsibility of Collecting Payments on the Invoices; Banks Leave that Responsibility
to You
Since the factoring company has purchased your invoices, they now have the responsibility to collect the payments. This allows you to save money by not having to pay your own employees to manage the accounts receivable process. On the other hand, the bank does not perform any accounts receivable tasks, so you have to use and pay your staff to collect the invoices. In many cases, the factoring company also provides you credit protection. This means the factor, not you, takes the hit if a customer does not pay or goes bankrupt before the invoice is paid. Of course, you have no credit protection with the bank since you still own the accounts receivable invoices.
You can use either of these financing methods to operate your business more effectively. If you are considering either option and need more information, contact us and we can help you weigh the pros and cons based on the details of your business situation.
Some misconceptions about factoring
Many business people who have never used accounts receivable factoring have certain misunderstandings about it. These encompass everything from the details of a transaction, to the type of businesses that use factoring to create working capital for their company. The following are a few of the most common misconceptions, and some information to help us understand the facts better so that you can make smart decisions for your business based on reality.
Since the factoring company has purchased your invoices, they now have the responsibility to collect the payments. This allows you to save money by not having to pay your own employees to manage the accounts receivable process. On the other hand, the bank does not perform any accounts receivable tasks, so you have to use and pay your staff to collect the invoices. In many cases, the factoring company also provides you credit protection. This means the factor, not you, takes the hit if a customer does not pay or goes bankrupt before the invoice is paid. Of course, you have no credit protection with the bank since you still own the accounts receivable invoices.
You can use either of these financing methods to operate your business more effectively. If you are considering either option and need more information, contact us and we can help you weigh the pros and cons based on the details of your business situation.
Some misconceptions about factoring
Many business people who have never used accounts receivable factoring have certain misunderstandings about it. These encompass everything from the details of a transaction, to the type of businesses that use factoring to create working capital for their company. The following are a few of the most common misconceptions, and some information to help us understand the facts better so that you can make smart decisions for your business based on reality.
Is Factoring a Loan?
No. Even though it is a financing strategy it does not work exactly like a loan. You can use the funds as you would the cash from a credit loan or bank loan, but factoring is not considered a loan, but a sales transaction. It does not show up on your balance sheet as debt. Therefore it does not create a liability on your balance sheet or affect your debt to equity ratio except to lower it if you use the funds to pay off any debts with the proceeds. The factor actually purchases your invoices and advances you 70 to 90 percent up front, and the remainder after the invoice payments are collected, minus the factoring fee. The fee typically ranges from 1 to 3 percent.
Is Factoring an Expensive Form of Finance?
This depends on your situation. If you use the funds to grow your business through marketing or to eliminate payroll expenses for accounts receivables, factoring can actually save you money. Factors generally take on many of your accounts receivable tasks. For example, they examine the credit of your customers, collect the payments on the invoices, and provide you with financial reports that detail the status of your receivables. While the rates may be higher than some low-interest business loans, that’s irrelevant if you can’t qualify for the loan. So you really have to think about the cost of not having the cash you need to grow your business by funding acquisitions, implementing marketing and promotions, or purchasing more inventory or supplies. In addition, credit lines are limited while the funds you receive from factoring can increase right along with your sales volume.
Is Factoring Only for Businesses About to Go Under?
While it is true that businesses experiencing a tough season can benefit from factoring, many businesses turn to factoring for the exact opposite reason. Factoring is a popular financing strategy for businesses that are growing rapidly. Sometimes these are newer companies that lack an established credit history or that have financial ratios that do not allow them to qualify for traditional bank loans. By using factoring funds to grow their sales volume, they also increase their total profits. Also by decreasing the time interval for outstanding invoices, some are able to capitalize on early payment discounts from suppliers.
No. Even though it is a financing strategy it does not work exactly like a loan. You can use the funds as you would the cash from a credit loan or bank loan, but factoring is not considered a loan, but a sales transaction. It does not show up on your balance sheet as debt. Therefore it does not create a liability on your balance sheet or affect your debt to equity ratio except to lower it if you use the funds to pay off any debts with the proceeds. The factor actually purchases your invoices and advances you 70 to 90 percent up front, and the remainder after the invoice payments are collected, minus the factoring fee. The fee typically ranges from 1 to 3 percent.
Is Factoring an Expensive Form of Finance?
This depends on your situation. If you use the funds to grow your business through marketing or to eliminate payroll expenses for accounts receivables, factoring can actually save you money. Factors generally take on many of your accounts receivable tasks. For example, they examine the credit of your customers, collect the payments on the invoices, and provide you with financial reports that detail the status of your receivables. While the rates may be higher than some low-interest business loans, that’s irrelevant if you can’t qualify for the loan. So you really have to think about the cost of not having the cash you need to grow your business by funding acquisitions, implementing marketing and promotions, or purchasing more inventory or supplies. In addition, credit lines are limited while the funds you receive from factoring can increase right along with your sales volume.
Is Factoring Only for Businesses About to Go Under?
While it is true that businesses experiencing a tough season can benefit from factoring, many businesses turn to factoring for the exact opposite reason. Factoring is a popular financing strategy for businesses that are growing rapidly. Sometimes these are newer companies that lack an established credit history or that have financial ratios that do not allow them to qualify for traditional bank loans. By using factoring funds to grow their sales volume, they also increase their total profits. Also by decreasing the time interval for outstanding invoices, some are able to capitalize on early payment discounts from suppliers.
Is Factoring a Long-Term Arrangement?
Although many companies and industries use factoring as an ongoing financing strategy, a long-term commitment is not required. Some companies use it as a short-term strategy to improve their financial standing for a traditional bank loan, navigate seasonal supply and demand issues, jump-start growth, acquire other businesses' assets, or expand operations.
Factoring: Some More Common Concerns
Over the years there have been many companies considering factoring that have had concerns and questions in common. Here are some of the questions we hear most frequently. Let’s look at 6 common questions concerning factoring in general, as well as assignments, billing, and posting of your accounts receivable invoices.
1. Do I lose control of my billing and posting?
No. Here’s how the process works: You continue to create your invoices, and the factoring company posts the payments when they get paid. The factor provides you with a posting report, and many times you can view the paid and outstanding invoices daily via the Internet.
2. What if a payment is made on an invoice I did not factor?
Even if the payment is sent to the factor, you still receive 100% of the payment. If the invoice was not factored, the factor simply passes on the payment to you and no fee is charged.
3. How often can I factor my invoices?
You determine your factoring schedule based on your cash-flow needs and your invoices. There is no restriction on how frequently you can factor if you have a verified invoice for goods and services provided.
4. Can I qualify for factoring with a compromised credit history?
Yes. Most factoring companies look at the credit history of your customers to determine if and when they pay their invoices. This helps them determine when they will receive payment on the invoice. The factor will probably not even look at your personal credit history.
5. How Long Does it Take to Get Funded the First Time?
You will likely be pre-qualified over the phone, and asked to submit an application and the necessary documentation. Once you submit the required paperwork to the factoring company, it can take as little as 24 hours to get funded. Normally, the funds are wired to your account electronically.
6. Can I choose how many invoices to factor?
Yes. We can easily provide you with a facility that has no minimum requirements. Simply let us know that this is your preference. It may be to your advantage, based on your dollar value, to go with a factoring company that has minimums if you plan on factoring for a long period of time. You may gain access to better rates by doing so. Of course, we will help you determine what is best for you depending on your specific situation, but ultimately you will decide what works best for you and your company
Although many companies and industries use factoring as an ongoing financing strategy, a long-term commitment is not required. Some companies use it as a short-term strategy to improve their financial standing for a traditional bank loan, navigate seasonal supply and demand issues, jump-start growth, acquire other businesses' assets, or expand operations.
Factoring: Some More Common Concerns
Over the years there have been many companies considering factoring that have had concerns and questions in common. Here are some of the questions we hear most frequently. Let’s look at 6 common questions concerning factoring in general, as well as assignments, billing, and posting of your accounts receivable invoices.
1. Do I lose control of my billing and posting?
No. Here’s how the process works: You continue to create your invoices, and the factoring company posts the payments when they get paid. The factor provides you with a posting report, and many times you can view the paid and outstanding invoices daily via the Internet.
2. What if a payment is made on an invoice I did not factor?
Even if the payment is sent to the factor, you still receive 100% of the payment. If the invoice was not factored, the factor simply passes on the payment to you and no fee is charged.
3. How often can I factor my invoices?
You determine your factoring schedule based on your cash-flow needs and your invoices. There is no restriction on how frequently you can factor if you have a verified invoice for goods and services provided.
4. Can I qualify for factoring with a compromised credit history?
Yes. Most factoring companies look at the credit history of your customers to determine if and when they pay their invoices. This helps them determine when they will receive payment on the invoice. The factor will probably not even look at your personal credit history.
5. How Long Does it Take to Get Funded the First Time?
You will likely be pre-qualified over the phone, and asked to submit an application and the necessary documentation. Once you submit the required paperwork to the factoring company, it can take as little as 24 hours to get funded. Normally, the funds are wired to your account electronically.
6. Can I choose how many invoices to factor?
Yes. We can easily provide you with a facility that has no minimum requirements. Simply let us know that this is your preference. It may be to your advantage, based on your dollar value, to go with a factoring company that has minimums if you plan on factoring for a long period of time. You may gain access to better rates by doing so. Of course, we will help you determine what is best for you depending on your specific situation, but ultimately you will decide what works best for you and your company