A challenge to any business owner, particularly a small business owner, is to know the differences between business funding options. Different programs or options can sound similar but actually have a very different short and long-term impact on business finances.
A good example of this is the differences in accounts receivable financing vs factoring. While financing and factoring may seem as if it is the same thing, there are differences that need to be clearly understood before choosing one or the other.
What is Factoring?
Factoring involves a business selling invoices (account receivables) to a third-party, the factor. In turn, the factor evaluates the creditworthiness of the paying customer, not the business, to determine if funding will be an option. The factor then provides typically 80 plus percent of the value of the accounts receivable to the small business for immediate cash flow.
The factor then collects from the customer and, from the 15-20% held back, deducts the fees for the service. The residual amount is transferred to the small business.
What is Financing?
The big differences in accounts receivable financing vs factoring is more like a traditional type of cash advance or loan. However, instead of requiring collateral or a personal guarantee, the accounts receivable serve as the backing for the funds.
In some ways, this is like a line of credit with about 70 to 90% of the value available for the business to use. However, with a line of credit there is usually a management fee, typically around 2%, on the amount of money borrowed. There is also interest charged on funds used until repaid.
When considering accounts receivable financing vs factoring, keep in mind that financing is more structured and typically requires that the company use all accounts receivables in the process. Factoring is more individualized and will allow the company to pick and choose which invoices they wish to sell.
