What Is the Difference Between Factoring and Accounts Receivable Financing?

A woman in Accounts Receivable sits behind a desk counting cash while sticking receipts on a desk spike.

As 2020 comes to a close, business owners’ concerns about cash flow are sizable, with nearly 60% expressing they have been negatively or very negatively impacted due to COVID-19’s effect on the economy in a recent small business poll. While frivolous expenses and big purchases are definitely on the chopping block, many businesses are also examining their receivables. They are considering invoice factoring and invoice financing to increase cash flow to their companies—sooner rather than later. What are accounts receivables, and how does factoring receivables help your cash flow? These are important questions, and there are finance factors to consider before deciding to take these financing routes. Here’s what to know.

What is Accounts Receivable Financing?

Also called “invoice financing,” accounts receivable financing advances your business money based on the value of your outstanding invoices. Accounts receivables count as assets, and their worth is equal to the invoices’ outstanding balances (customers that have been billed but have yet to pay). Like a business loan, the unpaid invoices are the collateral finance companies use to determine how much money to “lend” your company. The finance company will advance you up to 100% of an invoice’s (or invoices’) value and charge a fee based on the invoice’s value each week until the financed invoices are paid in full. Some finance companies also offer selective receivables financing. In this option, the borrower can choose which receivables to advance for early payment.

Although accounts receivable financing is sometimes confused with factoring, there are important differences. The most significant difference is how the collection of the invoices is handled. With accounts receivable invoicing, you maintain ownership and control of your receivables. You still communicate with your customers and collect the payments. Your customers and clients will never know you have taken out a loan on their invoices. It may not seem like a big deal, but if your customers find out you sold their invoices to get cash, they may think your business is struggling, which could affect future business transactions.

It’s essential to know the fees and length of the financing contract before you sign on with an accounts receivable financing company. Fundbox offers accounts receivable financing at a reasonable rate of 4.66% for a 12-week repayment plan. There isn’t a minimum amount needed to be approved, and each week your payment to Fundbox includes the small fee. If you want to pay the contract off early, there are no penalties.

What is Factoring and How Does it Work?

Like accounts receivable financing, invoice factoring advances your business money based on the amount of the outstanding invoices. However, with factoring, you sell your open invoices to the factoring company (a “factor”), and the factor collects payments for the invoices directly from your customers. Unlike accounts receivable financing, your company does not receive 100% of the invoice amount.

Typically, with invoice factoring, the business receives approximately 80% of the invoice amount. After the factor collects the entire invoice amount, the company receives the remainder of the balance minus the factor’s fees. Fees for factoring can get pretty hefty and may include a percentage of the invoice value plus service fees, origination fees, credit check fees, and more.

As we mentioned earlier, because the factoring company now controls the collection of the unpaid invoices, they will notify your customers of the transaction and how to pay the invoice. The notice could alert your customers to your cash flow issues and potentially hurt your company’s reputation. On the other hand, you may want to give the responsibility of collection to another company.

Since the factoring company now controls your invoices, you may find the factor has too much influence on what customers you are allowed to do business with in the future. If a customer defaults or is slow on a payment, the factor may terminate the relationship. Also, the factor may require a long-term contract with your business, which means giving up control of your invoices for longer than you desire.

The Right Choice

Both accounts receivable financing and factoring are good alternatives to bank loans for small businesses needing a quick cash infusion that can’t wait for lengthy approvals. However, there are considerable differences between the two. Make sure you weigh the advantages and disadvantages of these types of financing.

If time is your biggest concern, factoring typically takes a bit longer than accounts receivable financing. Fundbox allows your business to choose how many invoices you want to finance. And depending on your bank, you may see the money in your business account in as little as one day.

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Tags: Accounting and TaxFinancingInvoice Factoring