Factoring vs Accounts Receivable Financing
Factoring and accounts receivable financing are two types of business funding that allow entrepreneurs to get the funding they need without relying on banks. There are some crucial differences between each that any business owner or potential owner needs to know.
What is Factoring?
This occurs when a commercial finance company, or factor, purchases the outstanding accounts receivable a business has. This process generally gives an advance to the business between 70 to 90 percent of the receivable value at the time of the purchase.
There’s also an associated fee, based on the total value of the related invoice. The fee is usually a percentage that ranges from 1.5 to 5.5. When the invoice gets collected, the balance is obtained, minus any fees incurred.
Also, there’s usually a contract wherein a company can pick which invoices it wants to sell to the commercial finance company. After an invoice is purchased, the financier manages that invoice until it’s paid off. During that time, the factor can do credit checks, look at credit reports and mail or document payments, because it is serving as a credit manager. It’s relatively easy for a company to qualify for factoring, even if it is new or going through financial difficulties.
What About Accounts Receivable Financing?
This option has some aspects that are akin to a traditional bank loan. However, whereas loans can be secured with collateral, accounts receivable financing is based entirely on a pledge of the company’s assets related to the accounts receivable to a finance company.
Generally, companies are permitted to borrow amounts of 70 to 90 percent of the receivables that qualify. Like the previous type of funding arrangement, there’s a fee structure. It’s generally one to two percent of the outstanding amount, and is called the collateral management fee.
In order for a business to qualify for this possibility, an invoice usually must be no older than 90 days, and the associated business must be deemed by the financier to have a solid credit history. Compared to the funding method discussed above, accounts receivable financing doesn’t have as much flexibility. That’s because rather than choosing particular invoices, a company must give them all to the finance company for collateral.
Additionally, some businesses may not qualify for this alternative unless they make at least $75,000 per month in sales. That makes it an unrealistic choice for businesses that are small or just getting started.
Hopefully you now have a clear idea of the differences between these two financing types, especially if you may need to use them in the future.