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Invoice Factoring
How to Choose Between Accounts Receivable Factoring and Financing: Key Considerations
In this current economic environment, healthy cash flow is critical. According to a JP Morgan & Chase report, only half of all small businesses hold a cash buffer of less than one month. For companies facing the challenge of maintaining a robust cash flow, deciding on the right lending partner and/or financial solution is key. Many business owners will consider several options; so understanding the nuances of accounts receivable financing vs factoring is more crucial than ever. This guide will unpack these financing options, ensuring you have all the information you need to make the right choice.
Accounts Receivable Financing: Definition and How it Works
Accounts receivable financing is a financial avenue where businesses use their outstanding invoices as collateral to gain immediate working capital. This option allows you to borrow against the amounts customers owe you, injecting liquidity into your operations without waiting for invoice settlements.
Example: Consider a tech startup that’s invoiced a major client with a 90-day payment term. To bridge the cash flow gap and fund immediate growth initiatives, the startup opts for AR financing. They receive a significant portion of the invoice value upfront from a financing company, which they’ll repay as the client settles the invoice, along with a fee for the financing service.
Here’s the typical step-by-step process of accounts receivable financing to give you a clearer picture of how it unfolds:
Step 1: Selection of Invoices
The business identifies which outstanding invoices it wants to finance. This selection might be based on the due dates of the invoices, the creditworthiness of the invoiced clients, or the immediate cash flow needs of the business.
Step 2: Application and Review
The business submits an application to the financing company, along with the details of the selected invoices. The financing company then reviews the application, assessing the credit risk associated with the invoiced clients and the business’s overall financial health.
Step 3: Approval and Agreement
Once approved, the financing company sends their agreement outlining the terms of the financing, such as the advance rate (the percentage of the invoice value that will be paid upfront), the fees, and the repayment schedule. The business reviews and accepts the terms.
Step 4: Funding
The financing company advances a portion of the selected invoices’ value to the business. This advance rate typically ranges from 70% to 95% (in FundThrough’s case, often 100%, less an upfront fee) of the total invoice value, giving the business the working capital they need.
Step 5: Repayment
The business repays the financing company according to the agreed terms while putting their cash advance to work. This repayment includes the advanced amount plus any associated fees.
Step 6: Settlement
Once all invoices involved in the financing arrangement have been settled by the business’ clients and the financing company has been repaid, the transaction is complete. Any remaining balance from the invoices, after deducting the advance and fees, is then remitted to the business.
Accounts Receivable Factoring: Definition and How it Works
Accounts receivable factoring, on the other hand, involves selling your outstanding invoices to a factoring company. In exchange, you receive an advance on the majority of the invoice value, while the factoring company takes on the responsibility of collecting payment from your clients.
Example: A manufacturing company facing delayed payments from distributors chooses AR factoring for immediate cash flow relief. Upon selling its invoices to a factoring company, it receives cash upfront, less a factoring fee, bypassing the waiting period for distributor payments.
Here’s the typical step-by-step process of accounts receivable factoring to give you a clearer picture of how it unfolds:
Step 1: Invoice Selection
The business decides which outstanding invoices it wants to factor. This decision may be influenced by various factors, including the payment terms of the invoices and the immediate financial needs of the business.
Step 2: Factoring Application
The business submits these selected invoices to a factoring company, along with a factoring application. The factoring company evaluates the financial strength and creditworthiness of the invoiced customers more closely, less so for the business itself.
Step 3: Factoring Agreement
Once approved, the factoring company sends the factoring agreement. This agreement details the purchase price of the invoices (which is typically a percentage of the invoice value), the fee structure, and the terms of the factoring arrangement.
Step 4: Advance Payment
The factoring company then advances a portion of the invoice value to the business. This advance is usually between 70% and 95% of the total invoice value (FundThrough often advances 100% of the entire invoice, less an upfront fee), providing immediate cash flow to the business.
Step 5: Collection
The factoring company takes over the responsibility of collecting the payment from the business’s clients. This step differentiates factoring from accounts receivable financing as the factoring company directly interacts with the clients. At FundThrough, we make sure that any interactions with your customers are professional, and we only contact them with your permission. Learn about how we work with your customers.
Step 6: Final Settlement
Once the factoring company has collected payment from the clients, it remits the remaining balance of the invoices to the business (if there is one), minus the previously advanced amount and the factoring fees.
Accounts receivable financing vs factoring: What's the difference?
Understanding the nuances of accounts receivable financing versus factoring is essential for business owners seeking to bolster their cash flow and financial stability. These two types of financing provide lifelines to businesses needing immediate capital but differ in structure, impact, and application. As you consider the financial landscape of your business, including factors like credit history, the nature of your outstanding accounts, and your relationship with customers, it becomes crucial to dissect these options thoroughly.
How to Choose the Best Option for Your Business
At first glance, the challenge may seem straightforward: customers demand invoices with extended payment terms, leaving business owners in need of immediate cash – not just another account receivable. This challenge isn’t exclusive to large corporations; it hits small businesses particularly hard.
According to recent data on small business credit, capital, and cash flow, cash flow is a top challenge for 22% of small business owners, closely followed by the costs of running the business at 19%. With many small businesses reporting daily incomes barely exceeding expenses, it’s obvious that maintaining positive cash flow is an ongoing struggle across various industries. The good news is that small businesses have lots of options to correct this issue. They can explore traditional loans offered by financial institutions, or consider alternative financing solutions like accounts receivable financing and factoring.
So, how do you choose between accounts receivable financing or accounts receivable factoring? When deciding, several critical factors come into play. Evaluating these factors will help you determine which option best suits your business’s needs and financial goals:
- Size of Outstanding Balances and Nature of Outstanding Accounts: Assess whether you’re dealing with large invoices or foresee a need for a significant amount of funding to support growth projects or other financial commitments. Oftentimes, large invoices are recommended for factoring, while smaller invoices are recommended for financing.
- Advance Rates and Fee Schedules: Evaluate the percentage of the invoice value you receive upfront, as it’s crucial for maintaining a positive cash flow. With factoring, the transaction fee is withheld from the advance before it lands in your bank account, whereas with financing, a portion of the fee is added to each payment.
- Repayment Plans: Consider the repayment plans associated with each option. With factoring, the business owner’s customer redirects payment to the receivable factoring company when an eligible invoice is factored. However, with financing, the customer pays the business owner directly for a financed invoice. In both cases, the customer is only obligated to pay according to the invoice terms; it’s who they are paying that is different.
- Parties Involved: Assess the level of commitment and parties involved in each financing solution. With factoring, the business’ customer is involved because they have to redirect payment, while with financing, the customer isn’t involved.
- Your involvement in Collections: Consider the mental burden associated with each option. When financing invoices, you have to make sure funds are available to meet payment obligations to the financing company. Conversely, when factoring invoices, you don’t have to monitor your bank account closely, as the fee is already deducted from the advance. Also, the factoring company handles payment collection and manages late payers. (At FundThrough, we always communicate with you before contacting your customers.)
By carefully analyzing these aspects alongside the potential impact on customer relationships, and the overall financing rate, you can make an informed choice. This decision should not only address your current cash flow challenges but also align with your long-term financing needs
Real Use Cases From FundThrough Clients
We looked at our clients’ experiences to understand how invoice factoring vs. invoice financing helps them differently in various situations. Here’s a glimpse into their perspectives, shedding light on choosing the right funding option and exploring the potential of getting invoices paid early to spur growth.
| Use Cases: AR Financing | Use Cases: AR Factoring | ||
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Need: A source of alternative lending, because the bank wasn't coming through. "While we started as self-funded, there came a point where it wasn’t feasible anymore." MapleX Naturals used accounts receivable financing through FundThrough to manage their cash flow and support growth. They chose this method for its quick access to funds, flexibility, and the ability to maintain growth without waiting for clients to clear previous dues. This strategy was particularly beneficial for managing their cross-border supply chain and long payment terms. Read their story here. |
Need: Robust funding solutions for large-scale projects under tight cash flow conditions. "There is definitely a sense of peace of mind knowing that if the client doesn’t pay the invoice, we can factor it, and we can make our payments." Steel River used AR factoring with FundThrough to navigate a critical cash flow challenge during a $50 million project. They chose this method for its rapid funding capabilities and flexibility. Factoring was essential for maintaining operations and meeting significant expenses, like payroll and supplier payments, without the need for client payments to clear. Read their story here. |
Explore accounts receivable funding with FundThrough
Why Get Your Accounts Receivable Paid Early with FundThrough?
At FundThrough, we’re not just about providing fast and flexible funding; we’re about offering a tailored financial partnership that aligns perfectly with your business’s unique needs and growth trajectory. Our AI-powered platform is designed to revolutionize the way business owners access working capital, making the entire process seamless, efficient, and incredibly user-friendly. Here’s a deeper look into how we empower your business with our distinctive approach:
- Rapid, AI-Enhanced Processing: With FundThrough, you’re not just getting quick access to capital; you’re experiencing the cutting edge of AI-powered invoice funding. Our technology ensures your funding process is as efficient as possible, minimizing wait times and maximizing productivity.
- Customized Funding Solutions: We understand that no two businesses are the same, which is why our accounts receivable factoring solution features unlimited funding based on the size of your outstanding customer accounts. This means your funding potential grows in tandem with your business, ensuring you always have access to the capital you need, when you need it.
- Seamless Integration with Accounting Software: Our platform integrates effortlessly with popular accounting tools like QuickBooks and Enverus (OpenInvoice), streamlining your funding process even further. This integration allows for a one-click funding experience (after approval), pulling eligible invoices directly into your account with zero hassle.
- Transparent, Single-Fee Structure: No more hidden fees and complex pricing models. At FundThrough, we believe in transparency, which is why we offer a straightforward, single up-front fee. You’ll always know exactly what you’re paying, with no surprises. See our pricing page.
- No Long-Term Commitments: Flexibility is key in business finance, and we’re committed to providing it. With FundThrough, there’s no need for long-term contracts; you fund the invoices you want when you want, and once your customer pays their invoice, your obligation ends.
- Dedicated Support from Real People: Our dedicated account managers are more than just support staff; they’re your partners in funding. They’re here to provide personalized assistance every step of the way, ensuring your funding experience is smooth, successful, and tailored to your needs.
By choosing FundThrough, you’re not just choosing a funding solution; you’re choosing a partner dedicated to your business’s success. Our innovative approach combines the best of technology and personalized service to provide a funding experience that’s fast, flexible, and fundamentally designed to support your growth.
Ready to Get Your Invoices Paid Early?
Deciding on the right financing option hinges on a deep understanding of your business’s needs and financial situation. Whether it’s the predictability and control offered by accounts receivable financing or the swift, hands-off capital infusion from factoring, choosing the right strategy is crucial for maintaining operational agility and ensuring long-term growth.
FAQ
Is factoring the same as receivables financing?
No, factoring involves selling your invoices for immediate cash, while receivables financing is a loan based on your outstanding invoices.
What is the difference between factoring and bill financing?
Bill financing is another term for invoice financing, where a business uses its unpaid bills as collateral for a loan, whereas factoring involves selling those bills outright.
What is the difference between invoice factoring and accounts receivable factoring?
They refer to the same thing—where you sell your outstanding invoices to a third party in exchange for immediate cash.