Often in business, as in finance, specific terms are used incorrectly. Two very different yet often interchanged terms in funding are financing accounts receivables and factoring, also known as factoring accounts receivables.
Both can supply a business with the necessary working capital to maintain daily operations. However, there are significant differences between the two making one a better option than the other for many businesses. Understanding the differences with financing accounts receivables and factoring will ensure you always understand the funding source best suited to your needs.
The Basics of Financing Accounts Receivables
When discussing financing accounts receivables keep in mind this is a traditional type of loan from a lender. A financial institute considers the accounts receivables and the net worth of a business to establish the loan amount.
When financing accounts receivables, the loan is a debt on the business. It typically includes a personal guarantee by the business owner or owners. In addition, just like any SBA (Small Business Association) loan, traditional bank loan or a line of credit, it will include very specific application requirements.
An application for a loan based on financing accounts receivables will typically include information about the business and the owners and will take considerable time and effort to complete. Then, the loan itself may take weeks to approve. Interest is charged on the amount provided by the lending institute over the term of the loan.
Factoring
Factoring accounts receivables is very different than financing accounts receivables. It is not based on the net worth of the business, financial information, or guarantees provided by the business owner(s). Instead, it is based on the value of the accounts receivables being sold to the factor.
Think of factoring as the collateralization of the business’s commercial or B2B accounts receivable (AR). There is no debt against the business and no interest to pay because it is not a loan. Instead, it is an advance of a percentage of the value of the AR, with the balance less factoring fees provided upon final payment of the invoice by the buyer.
Without all the complications and long-term financial implications of financing accounts receivables, factoring is a preferable option for entrepreneurs, start-ups and small to large businesses. It is flexible, effective and provides the working capital your business needs when you need it..
At United Capital, we work with small businesses to see the direct advantages in factoring over financing accounts receivables.
