What is The Difference Between Factoring and Accounts Receivable Financing?

When you're turned down for a traditional business loan and other common financing options, such as online lending, investors, and crowdfunding, it isn't time to give up. There are still options available to you. Accounts receivable financing and factoring are fairly easy to qualify for compared to traditional financing.There are still options available to y

In this article, we’ll discuss the difference between factoring and accounts receivable financing and why you might choose one over the other.

What Is Accounts Receivable Financing?

Accounts receivable financing is similar to a secured loan. While a secured loan requires tangible assets such as equipment, property, or even the business owner's personal assets, accounts receivable financing uses the company's accounts receivable as collateral. This type of financing usually has strict qualifications. 

The company’s accounts receivable must meet the financing company's qualifications:

  • 70% to 95% is advanced to the company upon approval 
  • Pay a 1% to 2% fee to the financing company 
  • Loan amount will usually be net of financing fees 

The company seeking financing doesn't have to sell its accounts receivable. Accounts receivable are simply being used as collateral. The company will still need to continue collecting payments from customers, and the accounts receivable and credit processes don't need to change.

What is Factoring?

Invoice factoring is a process in which a company, called the "factor,” buys your accounts receivable for 70% to 95% of its value. The factor will then take over collecting payment from customers. It will also charge a fee for its services that can range from 1.5% to above 3% of the accounts receivable value. The fee will vary based on the risks the factor has identified and other aspects of the factor's process. The amount advanced to the company will be net of factoring fees.

Accounts receivable financing and factoringSource

Using factoring means your customers will be working with a different company. This can be a jolt to your normal process and customers might think you are going out of business. The best way to handle this scenario is to prepare far in advance, and make sure your customers are aware of what is about to happen and why. It can also be useful to build processes into your business to make it easy to offload accounts receivables.

It is typical to not sell your entire accounts receivable, and you can choose which outstanding invoices to factor. Check here to see a visual guide to the invoice factoring workflow.

AR Financing vs Factoring: What’s the Difference?

Knowing the differences between factoring and accounts receivable financing can help you decide which option might be best for your business.

Both advanced funds are based on a percentage of the value of accounts receivable and charge similar financing fees. In both cases, funds are advanced net of fees… so what are the differences between factoring and accounts receivable financing? 

With factoring: 

  • A company is buying your accounts receivables and taking over the collection process
  • It’s a high-impact scenario in that impacts both your company and your customers
  • You will probably need to set up a new factor contract for each cash advance that is requested

With accounts receivable financing:  

  • You still run your collection process 
  • It’s a seamless scenario to your customers and your A/R and credit processes
  • Acts as a line of credit that you can draw on, making the entire process easier than factoring

Who Should Use Accounts Receivable Financing or Factoring?

Consider this scenario: 

You have a net 60 for outstanding invoices. You start getting new customers, which requires ordering materials from suppliers. However, the company doesn't have enough cash or credit to cover the cost of materials. Traditional financing options aren't available. At this point, the company can't fulfill its orders.

That's where accounts receivable financing or factoring comes in. Depending on which option the company goes with, it sells off enough of its unpaid invoices (factoring options) to finance materials and fulfill its new customer orders. 

This replenishes working capital and allows the company to continue growing. At some point, the company should be able to finance orders using its own funds. This usually happens by reducing net terms enough that the company can cover new orders.

For more details on the process and loan structure of invoice financing, visit our blog “The Difference Between Invoice Financing And Factoring.”

Which Financing Is Right For Your Business?

There are a few components that go into this decision, but it can truly be as simple as qualifying for one over the other. 

Assuming both options are available to you, choosing to go with factoring means a more disruptive process since you lose control of payment collections. However, some companies may see that as an advantage because they are able to offload part of the process onto another company that is fairly good at that specific process.

On the other hand, choosing to go with accounts receivable financing means that you will remain in control of the payment collections process. This can be a good option for companies that want to continue their client communication as is and have the time and resources to manage payment collections in-house.

Another consideration is cost vs. value. Which option values your accounts receivable or invoices highest and charges the lowest fees? If factoring is the winner, there is still the disruption of payment collections. But if you are ok with allowing someone else to take over that part of your process, factoring is a clear winner.

The above assumptions provide you with a few methods for evaluating which financing option to choose. Doing the necessary comparative research will allow you to fully understand how any decision will impact your business.

If your company is considering an invoice financing or factoring solution, it may be time to consider something even better. Apruve can help you set up a trade credit and A/R automation program for your business buyers, extending your working capital while enhancing the buyer experience. Learn more about Apruve or contact Apruve’s specialists to sign up for a demo today! 

 


ABOUT APRUVE

Apruve enables large enterprises to automate long-tail credit and A/R so you can stop spending 80% of your time and resources on 20% of your revenue. We partner with each of our customers to solve their unique credit, payment, and accounts receivable challenges and build the right credit solutions for your markets, customers, and goals. 

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