A small business owner in need of capital has a number of options to consider. Should they apply for a traditional loan from a bank and are they likely to be approved? Or should they consider a form of alternative financing? Two alternative options are business factoring and accounts receivable financing. Often thought to be the same thing, they are in fact quite different. Here are some differences to consider:
Business Factoring is when a business owner sells account receivables, at a discount, to a third- party funding source in order to raise capital. This is typically a short-term solution, up to two years. To illustrate factoring, let’s look at a business deal between company A and company B. Company A takes advantage of an opportunity to purchase inventory at a discounted price and turns around and sells the inventory to company B for a great profit. However, company A now has limited cash flow while company B has 60 days to make payment. In this case, the “factor” would purchase the right to collect on the invoice at a discounted rate, typically 2 – 6 percent. The factor will pay company A 75 – 80 percent of the invoice amount up front and pay the remainder, minus the discount, upon payment. The factor will base it’s decision on the credit worthiness of the customer, or company B. The factor will run a credit check on the customer and deal directly with it’s accounts payable department. This has the potential to harm the business relationship company A has worked hard to establish.
Accounts Receivable Financing typically is less costly than factoring because the source of funding assumes less risk. The factor will buy an invoice based upon credit worthiness, but that is no guarantee that the invoice will in fact be paid. Accounts receivable financing is a loan secured by a company’s accounts receivables, not limited to the amount of one invoice. So in our illustration, company A would purchase the inventory and sell it to company B for profit. While waiting to receive payment from company B, company A would secure a loan through a company like National Business Capital based upon their average monthly accounts receivables. There is much less risk to the funding company because company A is responsible for any bad debt on the receivables pledged as collateral for the loan.
It’s always important to be well informed and educated on business factoring, accounts receivable financing and factoring accounts receivable before making financial decisions. Before you do, call National and speak with one of our knowledgeable business consultants to learn what your AR financing options are!
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Megan is passionate about helping business owners along their journey - providing them with relevant content they can use in their day-to-day operations.