Accounts Receivable Financing Vs Factoring | What to USe to Improve Cash Flow?

Today's business world is competitive, and you will need a beneficial cash flow to stay afloat. There are impeccable services businesses can rely on to free up money over the short term.

The leading options in the market are factoring and account receivable financing since they help to increase cash flow. With these services or receivables, small businesses owners have an effective alternative to standard traditional bank loans.

Businesses can send out invoices, and customers don't have to pay immediately, as they can offer upfront funds based on several options.  Many entrepreneurs try to piece the two together, but there are critical differences to know.

This article will look at accounts receivable financing vs. factoring to help you determine which service is best for your financing needs. Continue reading. 

What Is the Difference Between Factoring and Invoice Financing?

The main difference between factoring and invoice financing is in the criteria embraced in terms of the agreement. Each receivable offers its limits, and it is wise to stick by the opportunities presented. 

Both receivables benefit businesses and entrepreneurs with financing in advance of collection. To grasp the difference between the two receivables, you have to know when to use factoring or accounts receivable financing. 

a person using a notebook

Here are the critical things to help differentiate the two accounts receivable strategies:

What Is Factoring?

Factoring is a kind of financing where a business can sell all its outstanding invoices to a third party to increase cash flow. It serves as an alternative to a line of credit that is reliable and easy to get. 

The overdue payment is attributed to the actions of a company supplying services or goods before getting paid. It is a sale and not a loan meaning it will not impact your credit score like the traditional methods of bank financing. 

A "factor" or finance company will buy the accounts receivables, but an entrepreneur has the mandate to choose what to sell. The factor will manage the receivable until all the due payments are cleared. 

The factoring company will take the initiative to inform your customers of the agreement and how to make payments. In essence, the factor owns the invoice and also collects on the invoice.

How Does Invoice Factoring Work?

The key steps involved in invoice factoring are:

  1. Your company will provide customers with goods and services like any other business.

  2. An invoice is then sent to the target customers for the sold goods or services purchased. 

  3. Your company will have outstanding invoices due to be paid by the target clients.

  4. Now, you can engage and persuade the factoring company to buy the account receivables from your business. 

  5. The factoring service provider will immediately pay you a lump sum of the total invoice value if the invoices are valid.

  6. The factoring company will collect the invoices and cater to your customers' needs, clearing all payment fees and requests. 

  7. You will receive the remaining invoice amount from the factor- minus their factoring fee after the transaction is completed in full.

Advantages of Factoring 

  • It provides a steadfast boost to cash flow and financial planning.

  • It has no impact on your credit score.

  • It's a cost-effective way of outsourcing while saving time to manage your business.

  • Competitive prices due to the surge in the number of factoring companies.

  • Some customers may pay quickly because they respect a factoring company.

  • Factoring companies provide helpful information about target customers.

  • Protects your business against bad debts if you opt for non-recourse factoring.

  • As soon as the invoice is cleared, you will have cash and fund your subsequent orders.

  • The factor will credit check your customers and help trade with better quality clients. 

Disadvantages of Factoring 

  • It may reduce the scope of other borrowings.
  • The cost will mean a reduced profit margin on each invoice fulfillment.
  • There are hidden factoring fees and costs if dealing with fraudulent factoring companies.
  • Factoring companies may restrict funding against poor debtors, and you will need to manage these fluctuations.
  • Some customers may opt to deal with you directly.
two people shaking hands in the business meeting

What Is Accounts Receivable Financing?

Accounts receivable financing involves using unsettled invoices to grow your business. However, your business owns and collects on the invoice. 

Significantly, you get to control ownership of the invoices and enjoy an asset-based loan (ABL) with invoice financing. Your business is able to obtain short-term funding by using invoices as collateral. 

Your accounts receivable will act as collateral and give the bank or lender security and peace of mind. If you fail to repay the bank loans, the lender needs to convert the invoices into liquid assets. 

As collateral is involved in this form of financing, accounts receivable financing comes with a higher risk than invoice factoring. You also get to place other assets up for collateral like equipment or inventory. 

How Does Accounts Receivable Financing Work?

Here is how accounts receivable financing works:

  1. As a reputable business, you have outstanding invoices or account receivables due to be paid by customers.
  2. Work with an accounts receivable financing company and offer your unpaid invoices as collateral.
  3. The accounts receivable financing business will offer you a percentage of funds against the invoices and charge interest on the advance. 
  4. Decide when to repay the loan in installments. You can make payments on a weekly or monthly basis.
  5. As the business owner, you retain control of collecting invoices and figure out how to deal with customers.
  6. The accounts receivable financing company will charge interest as long as there is owed money against your invoices.
  7. If you default on the bank loan and fail to make the necessary payments, the financing company can take your invoices. It can also collect the invoices as compensation. 

Advantages of Accounts Receivable Financing 

  • Fast access to cash 
  • You don't have to hound your customers to make immediate payments.
  • Retain ownership of your business or equity 
  • Minimal credit requirements as invoices serve as collateral
  • It is friendly to small businesses as it is unsecured funding, and there is no collateral requirement.
  • It's fast, simple, and stress-free, giving you peace of mind to focus on growing your business.

Disadvantages of Accounts Receivable Financing 

  • Higher costs than the rates changed on other business loans.
  • Have to deal with lengthy contracts.
computer and notebook on the working desk

Which Is the Right Choice, Accounts Receivable Financing or Factoring?

The financing option you settle for depends on your business needs and how you plan to repay the funds. Therefore;

  • Accounts receivable financing is the best choice if you want to retain control of the payment process.
  • Choose invoice factoring if you want a factoring company to deal with the payment collection. 
  • If you want the amount you owe deducted from your invoices and get the remaining amount at less fee when customers pay, factoring will suit your needs.
  • Accounts receivable financing is the best solution if you plan to make regular payments.

Finally, if there are still some uncertainties left, we recommend seeking advice from some of the best formation services and registered agent services out there. Here are some of the most reliable:

Trusted Business Formation Services

Swyft Filings

Despite only doing business since 2015, their 100% positive reviews are speaking for themselves. Swyft Filings offers one of the best refund policies in the industry. On a bonus side the company also has no processing or cancellation fee for your refund. It is a great company to consider when looking to designate a registered agent service for your business.

BizFilings

BizFilings takes you through the whole process from quality check to post-incorporation and also offers on-going support. You can choose various payment plans based on the features you want and your budget. The features in the higher-end packages are also available in the lower-end packages but at an additional fee. With an A+ rating with the BBB, BizFilings is a trusted online formation service. 

SunDoc Filings

When compared to other formation services, SunDoc Filings provides volume discounts for multiple states and entities and equally amazing customer support. However, if you want a service that will save you money, you may find other services in the market that cost less. Also, you may not choose SunDoc Filings if you are looking for a service with payment packages with tons of features and free registered agent service.

Inc Authority

This is one of the most reputable companies you can pick as your registered agent service. Inc Authority has enough experience in the field, having been founded in the 1980s. Its free payment package stands out in what they offer. Loads of positive customer reviews speek for themselves how satisfied and happy with their services and their LLC formation speed their clients are. 

My Corporation

MyCorporation is known for offering a fast LLC formation process. If you wish to speed up the process turnaround time, you can use their expedited service, reducing the process from weeks to a few days, thoug for a fee. Nonetheless, MyCorporation is an excellent pick as your registered agent. It offers numerous payment packages with various features depending on your budget.

FAQs

What are the Two Types of Accounts Receivable Factoring?

Recourse factoring is a type of factoring financing where the invoice factoring company will charge bad debts back to your business. 

Non-recourse factoring is when a factor will not charge back bad debts to your business. The fees are likely to be higher.

What Is the Difference Between Pledging Accounts Receivable and Factoring Accounts Receivable?

Pledging account receivable is when you use your invoice as security to get a cash advance. The lender has recourse against the customer and the business. 

On the other hand, factoring accounts receivable is when you have to sell invoices to a factoring company. The lender has no recourse against the borrower.

Conclusion 

Wondering which is the best option for your business between accounts receivable financing and factoring? Both are incredible financing options that benefit your business by providing a cash boost in advance of invoice collection. They are good alternatives to bank loans for small businesses in need of urgent cash flow. 

The main difference is the kind of deals involved parties strike. It is also advisable to look at the advantages and disadvantages of each financing option. If stuck and want to learn more, seek professional business and marketing advice today.

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