Accounts receivable financing vs factoring

Having cash flow to cover business expenses is essential. Once in a while, timing is not on your side and you need a way to improve cash on hand for short-term needs. That’s when some transportation business owners start to look into accounts receivable financing vs factoring.

Each option offers a fast cash infusion without paying interest on a loan because they use an outstanding invoice a customer owes you. Learn about each option as you seek a feasible way to get cash fast for your business.

And when you’re finished, check out the other content in our ‘Finances of factoring’ article series:

• What is a factoring company in trucking and how does it help?
• How freight invoice factoring impacts trucking business finances
• Accounts receivable financing vs factoring
• Can factoring be used for temporary payroll funding?
• Best factoring company for trucking

What is accounts receivable financing?

Accounts receivable financing allows you to retain ownership of the customer invoice you’re using to obtain cash flow. You’ll still be in charge of collecting payment from the customer. Here’s a look at the process you can expect from this type of financing.

1. Take some time to evaluate unpaid invoices customers owe you.
2. Find a reputable accounts receivable financing company that will use your unpaid invoices as collateral.
3. Get an advance on the unpaid invoice from the financing company.
4. Begin making regular payment installments (weekly or monthly depending on your contract) that include interest on the money the financing company advanced you.
5. Continue working with the customer to ensure they pay the invoice as they normally would. As far as the customer is concerned, they see nothing different about the invoice.
6. As long as you owe the financing company money, it will charge you interest on the advance.
7. If you fail to repay the advance in the agreed-upon terms, the financing company can take ownership of the invoice and collect the money directly from the customer because the invoice was their collateral on the loan.

Generally, the interest rates on this type of financing are high, but they are reflected in an annual percentage. If you’re using the tool as a way to get short-term cash, you should only be paying interest for several weeks or up to a few months. The total interest you’ll pay then is far less than the annual percentage quoted to you.

Rates for accounts receivable financing vary immensely. Shop around for the best rates, but know that your credit history and time in business will also be factors in the quotes you receive. 

Who is accounts receivable financing best for?

Businesses with a strong hold on their finances should opt for accounts receivable financing. You have more responsibility with this financing type when compared with invoice factoring because you’ll still be collecting money from the customer and managing paying back the advanced amount based on cash flow from all sources.

Often, fast-growing businesses use this financing type to aid in meeting expenses while paying for large purchases, such as new trucks or equipment. It’s also ideal for new businesses that would struggle to secure a traditional bank loan. 

What is factoring?

Invoice factoring differs from accounts receivable financing in that the factoring company buys invoices from you and pays out a lump sum that you do not have to repay. Here’s a look at what you can expect when using this financing option.

1. Review your invoices for those that customers have not paid.
2. Select an invoice factoring company with favorable contract terms. 
3. The factoring company buys the invoices from you and deposits a lump sum into your bank account. 
4. Often, this lump sum is 80% of the invoice total, less a 3% to 4% fee for the company’s service.
5. The factoring company works directly with the customer to obtain payment for the invoice, including late fees, when applicable.
6. Once the customer pays the factoring company, the factoring company will pay you the remaining value of the invoice, less the factoring fee, which is also known as the discount fee.

In these contracts, you’ll only pay the discount fee, which is generally a single-digit percentage of the total invoice cost. This makes factoring cost-effective in most cases. For a $10,000 invoice with a 4% discount fee, that’s only $400 to have 80% of the total invoice value right away. 

Some invoice factoring contracts outline that you are still responsible for the invoice if the customer fails to pay. In other situations, the factoring company is responsible if the customer fails to pay. But if the factoring company takes on the risk, you’ll likely pay a higher discount fee.

Who is invoice factoring best for?

Invoice factoring is best for companies that experience seasonality or have slow-paying customers. That way, you have the money you need to keep the business going for a small fee. And in some cases, it takes a burden off your shoulders because your team no longer has to chase down the slow-paying customers to seek payment.

Comparing accounts receivable financing vs factoring

As you seek the best short-term financing option for your business, here’s a look at how various aspects of each option compare.

How financing is obtained

One major difference between accounts receivable and factoring is that accounts receivable financing works a great deal like a loan and you’re just using the invoice as collateral. In comparison, factoring is selling your invoices to a third party who will collect on them, for a fee.

Amount received

Accounts receivable financing provides you the full invoice amount as a lump sum that you then repay in installments, like a loan. In comparison, you’ll get only a percentage of the total invoice amount when you use factoring. Only when the customer pays the invoice will you get the remaining percentage of the total invoice value, less the discount fee.

Reason for financing

The reasons for using each financing type are different. Review the best ways to use these options to find the best fit.

Best use cases for factoring:

• Poor credit history
• Long invoice payment terms
• Limited time in business
• Few assets to borrow against for a traditional loan

Best use cases for accounts receivable financing:

• Outstanding invoices tend to be large
• Strong credit history with effective accounting strategies to repay the invoice advance
• Limited time in business
• Few assets to borrow against for a traditional loan

Some businesses use both financing strategies at different times in their business. Find the option that is the best fit for your current needs and adapt when you need to within your contract terms.

Get a short-term cash flow infusion

Regardless of which financing option you use, you’ll get a short-term cash flow infusion to help you meet your recurring expenses or to invest in new equipment for your business. Both options are good for new businesses with limited credit history, bad credit history or few assets to use as collateral for a traditional business loan.

FAQ

Sign up for a FreightWaves e-newsletter to stay informed of all news and trends impacting supply chain careers and operations.