Factoring Versus A/R
Financing: What’s the Difference?
By Tom Klausen
tight credit environment, more and more businesses are having to
turn to alternative and non-bank financing options to access the
capital they need to keep the gears of their business running
There are a
number of different tools available to owners of cash-strapped
businesses in search of financing, but two of the main ones are
factoring and accounts receivable (A/R) financing. Sometimes,
business owners lump these two options together in their minds, but
in reality, there are a few slight differences that result in these
being different financing products.
Factoring vs. A/R Financing: A Comparison:
Factoring is the
outright purchase of a business’ outstanding accounts receivable by
a commercial finance company, or “factor.” Typically, the factor
will advance the business between 70 and 90 percent of the value of
the receivable at the time of purchase; the balance, less the
factoring fee, is released when the invoice is collected. The
factoring fee—which is based on the total face value of the invoice,
not the percentage advanced—typically ranges from 1.5-5.5 percent,
depending on such factors as the collection risk and how many days
the funds are in use.
factoring contract, the business can usually pick and choose which
invoices to sell to the factor—it’s not usually an all-or-nothing
scenario. Once it purchases an invoice, the factor manages the
receivable until it is paid. The factor will essentially become the
business’ defacto credit manager and A/R department, performing
credit checks, analyzing credit reports, and mailing and documenting
invoices and payments.
financing, meanwhile, is more like a traditional bank loan, but with
some key differences. While bank loans may be secured by different
kinds of collateral including plant and equipment, real estate
and/or the personal assets of the business owner, A/R financing is
backed strictly by a pledge of the business’ assets associated with
the accounts receivable to the finance company.
A/R financing arrangement, a borrowing base of 70 to 90 percent of
the qualified receivables is established at each draw against which
the business can borrow money. A collateral management fee
(typically 1-2 percent) is charged against the outstanding amount
and when money is advanced, interest is assessed only on the amount
of money actually borrowed. Typically, in order to count toward the
borrowing base, an invoice must be less than 90 days old and the
underlying business must be deemed creditworthy by the finance
company. Other conditions may also apply.
Features and Benefits:
As you can see, comparing factoring and A/R financing
is kind of tricky. One is actually a loan, while the other is the
sale of an asset (invoices or receivables) to a third party.
However, they act very similarly. Here are the main features of each
to consider before you decide which one is the best fit for your
Offers more flexibility than A/R financing because
businesses can pick and choose which invoices to sell to the
Is fairly easy to qualify for. Ideal for newer and
financially challenged companies.
Simple fee structure helps the company track total costs
on an invoice-by-invoice basis.
Is usually less expensive than factoring.
Tends to be easier to transition from A/R financing to a
traditional bank line of credit when the company becomes
Offers less flexibility than factoring because the
business must submit all of its accounts receivable to the
finance company as collateral.
Businesses will typically need a minimum of $75,000 a
month in sales to qualify for A/R financing, so it may not be
available for very small companies.
Transitional Sources of Financing:
Both factoring and
A/R financing are usually considered to be transitional sources of
financing that can carry a business through a time when it does not
qualify for traditional bank financing.
period typically ranging from 12-24 months, companies are often able
to repair their financial statements and become bankable once again.
In some industries, however, companies continue to factor their
invoices indefinitely—trucking is an example of an industry that
relies heavily on factoring to keep its cash flowing.
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