As you research whether accounts receivables financing may be the right choice for your business, it’s important to distinguish this small business borrowing option from a commonly confused alternative—factoring financing.
Both accounts receivable financing and invoice factoring allow you to access funding based on the value of your receivables, but they’re not the same thing. The distinctions between the two can have a dramatic impact on the cost of your financing, as well as on your customer’s experience in paying for your goods and services.
Through accounts receivable financing, the accounts receivable financing company advances you money (80% to 90% of the invoice value) based on your business’s outstanding invoices. This type of financing takes the form of a loan agreement. You maintain control over your customer relationships and communications and are ultimately responsible for ensuring that the customer pays for your goods or services. Upon receiving payment from your customers, the lender will deduct their fees and send the remaining balance.
If you take out an accounts receivables finance loan and your customers pay their invoices earlier than expected, you will typically have the opportunity to pay off your accounts receivable loan ahead of schedule with no prepayment fee.
With accounts receivable factoring, a lender purchases the balance of your outstanding invoices for 80% to 90% of their face value. For instance, if you have $30,000 in unpaid invoices, the lender might pay you $25,500 for those invoices. At that point, the invoice factoring company takes on the debt of those outstanding invoices, reaching out directly to your customers for repayment.
The most distinct difference that you need to keep in mind is that with invoice factoring, you sell the balance of your invoices, and the factoring company takes responsibility for collection—this is known as an asset sales arrangement. If the customer doesn’t pay the invoice, the factoring company absorbs the loss. The reason this distinction is especially important: It costs you more.
Since the factoring company is purchasing your outstanding invoices and taking on the risk of your customer not paying, they’ll charge larger fees. On the flip side, one benefit to factoring: you don’t have to manage the unpaid invoices or track down payments from customers. The factoring company will handle all of that.
Sometimes, financing companies blur the lines between accounts receivable financing and invoice factoring, so just make sure you understand the terms and conditions of the lender you’re working with.
What is an account receivable loan?