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Key Points about Accounts Receivable Financing vs Factoring
- Understanding Cash Flow Solutions – Many businesses struggle with cash flow, and choosing between accounts receivable financing and factoring can help bridge financial gaps by providing immediate working capital.
- Accounts Receivable Financing – This option allows businesses to use unpaid invoices as collateral to receive cash advances while retaining control over collections and customer relationships.
- Accounts Receivable Factoring – In factoring, businesses sell their unpaid invoices to a third party at a discount, transferring the responsibility of collections while receiving upfront funding.
- Key Differences Between AR Financing & Factoring – The main distinctions lie in ownership of invoices, customer involvement, repayment structure, and fee schedules, influencing which option best suits a business’s needs.
- Choosing the Best Option – Factors such as invoice size, cash flow needs, creditworthiness, and level of involvement in collections play a crucial role in determining whether financing or factoring is the better choice for a business.
While 72 percent of small businesses are comfortable with their cash flow, that means nearly a third of small businesses are struggling with it – and situations can change as political and economic landscapes change. 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.
What is Accounts Receivable Financing?
Accounts Receivable Financing is a type of funding where businesses use unpaid invoices as collateral to draw capital against to secure immediate cash flow.
This financing method allows companies to receive a cash advance on their outstanding invoices instead of waiting for customers to pay. It helps businesses maintain steady cash flow, cover operational costs, and invest in growth without taking on traditional loans. Lenders typically charge fees or interest, and repayment is made in instalments on a set schedule, much like a line of credit.
How Does Accounts Receivable Financing Work?
Here’s the typical step-by-step process of accounts receivable financing to give you a clearer picture of what to expect:
Step 1: Apply to invoice financing companies and select a partner. You’ll receive term sheets that provide the details of each individual offer, such as funding limit and factoring fees. The next step is to provide all required documentation and information to complete underwriting your business, like articles of incorporation, copy of your government issued photo ID, and tax balance with the CRA or IRS.
Step 2: Submit invoices as collateral. You’ll submit customer contracts and invoices to use as collateral up to your funding limit.
Step 4: You draw money as needed. Whenever you need funding, you select invoices to use as collateral, and the factoring company pays them within 24 hours.
Step 5: You make payments on a schedule. Your account is debited for a fixed amount every month, which includes the principal plus a weekly or monthly interest fee. The cycle continues as long as you use the borrowing facility.
Example of Accounts Receivable Financing
Consider a tech startup that’s invoiced a major client with a 30-day payment term. They receive a request for proposal for a large project that they can’t take on without the cash flow from the invoice they just issues, so the startup opts for AR financing. Here’s how it would play out:
Calculating the costs: AR Financing
- Invoice amount: $20,000
- Payment terms: 30 days
- Funding Limit: $500,000
- Current principle: $20,000
- Interest rate: .05% per week
- Weekly principal payment (over 12 weeks): $1,666
- Weekly interest payment: $83.30
- Total weekly payment (until paid off or balance increases): $1,749.30
What if I miss a payment?
This is an understandable concern. Knowing about the possibilities can help you prepare. Here are a few things that could happen:
- Being charged a fee for a late payment or NSF in your bank account, impacting your cash flow.
- Needing to provide an update on expected payment date.
- Working out a payment plan with your factoring company.
- As a last resort, not being able to get more funding until the balance is repaid.
When reviewing a factoring company contract, it’s critical to understand what will happen if a payment is missed–and to know if the factor will work with you to get current again if you find yourself in that situation.
What is Accounts Receivable Factoring?
Accounts Receivable Factoring is a financial transaction where a business sells its unpaid invoices to a third party (a factor) at a discount to improve cash flow.
This process allows companies to access immediate working capital without waiting for customers to pay their invoices, much like AR financing. The difference is that the factor assumes the responsibility of collecting payments from customers. Factoring is commonly used by businesses with long payment cycles who want the additional benefits of factoring, such as outsourced collections and AR management.
How Does Accounts Receivable Factoring Work?
Here’s the typical step-by-step process of accounts receivable factoring process to give you a clearer picture of what to expect:
Step 1: Apply to invoice factoring companies and select a partner. You’ll receive term sheets that provide the details of each individual offer, such as advance rate and factoring fees. The next step is to provide all required documentation and information to complete underwriting your business, like articles of incorporation, copy of your government issued photo ID, and tax balance with the CRA or IRS.
Step 2: The factoring company underwrites your customer. You’ll also need to submit customer contracts and invoices for submitted work. The AR factoring company ensures your customer is creditworthy so they can count on them to pay their invoice on time. They will also verify that the invoices are real, accepted, and for completed work.
Step 4: You get paid early. Sometimes, the financing company advances a portion of the selected invoices’ value to your business upfront. This is called an advance rate, and it typically ranges from 70% to 95% of the total invoice value. (FundThrough advances you 100% of your invoice less an upfront fee.)
Step 5: Your customer pays. The business’ customer pays their invoice to the financing company according to the net terms.
Step 6: The AR factoring company sends you the remaining balance. If your arrangement has an advance rate, the factoring company will send you the remaining value of your invoice, less fees, once your customer pays. The transaction is now complete.
Example of Accounts Receivable Factoring
Consider the same a tech startup that we did before, but this time they’ve chosen accounts receivable factoring.
Calculating the Costs of Factoring: AR Factoring Formula
You can use this basic formula to calculate how much you’ll pay for factoring invoices:
Funding Amount = (Total Invoice Value × Advance Rate) − Factoring Fee
In the case of the tech startup, using the information we already have, here’s how much funding they could receive:
$19,450 = ($20,000 x .100) – $550
See the detailed breakdown for how we arrived at each number and the final funding total:
- Invoice amount: $20,000
- Payment terms: 30 days
- Funding Limit: $500,000
- Advance rate: 100%
- Interest rate: 2.75% per 30 days
- Total interest withheld from invoice amount: $550
- Total paid early: $20,000, less interest = $19,450
- Total paid in 30 days by customer: $20,000
What happens if my customer doesn’t pay?
If your factoring company approves your customer, they are certain from their credit expertise that your customer will pay. However, this concern is understandable, and knowing about the possible can help you prepare.
- The factor’s collections team tries to get a payment update from you and/or your customer. If an update is obtained, you’ll continue to pay interest (and additional fees oftentimes) until the invoice is paid.
- If an update on expected payment date can’t be obtained, the invoice could be charged back to you for payment, decreasing your company’s cash flow.
- The factoring company could hold back portions of or entire future advances to pay off the balance, further impacting business liquidity.
A good factoring company will always communicate professionally with your customers, contact you before contacting them, and work with you to get the balance repaid.
Accounts receivable financing vs factoring vs bank financing: pros and cons
Compare different small business financing solutions you’re considering:
AR Financing | AR Factoring | Working Capital Loans | Line of Credit | |
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Types of AR Factoring and Financing
- Recourse vs. Non-Recourse Factoring: In recourse factoring, the business remains responsible for the credit risk of unpaid invoices, meaning if a customer does not pay, the business must reimburse the factor or replace the invoice. In non-recourse factoring, the factor assumes the risk of non-payment, relieving the business of liability from bad debts. Because non-recourse factoring carries more risk for the factor, it usually comes with higher fees and stricter approval criteria.
- Notification vs. Non-Notification Factoring: In notification factoring, the customer is informed that their invoice has been sold to a factor and is instructed to make payments directly to the factor. In non-notification factoring, the customer remains unaware of the factoring arrangement and continues to pay the business as usual, with the factor receiving payments to a lockbox bank account. Non-notification factoring is often used to maintain customer relationships and avoid any concerns about third-party involvement, but it typically comes with stricter qualification requirements.
- Spot vs. Regular Factoring: In spot factoring, a business sells invoices on a one-time or as-needed basis, giving them flexibility without a long-term commitment. In regular factoring, also known as contract or whole-ledger factoring, a business consistently sells its invoices to a factor as part of an ongoing agreement. Spot factoring offers more control over which invoices are factored, but is less common. (By the way, FundThrough offers spot factoring!)
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 and their key differences 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, customer payments are redirected 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." -Dave Thompson, CEO, MapleX Naturals 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. “FundThrough allowed us to grow exponentially because we had the backing, knowing that the money was going to be there. We were able to take on some larger projects that if we had to self-fund, we would never have been able to achieve." -Ron Cedillo, VP of Lima Charlie Lima Charlie raised $8 million dollars in 30 days to take on their first government contract, unlocking a new growth channel for the company. They were able to assure their client that they were well-capitalized while paying their subcontractors on time without worry, enabling them to complete the job and establish a positive relationship with their new customer. Watch their story here. |
Explore accounts receivable funding with FundThrough
How to Qualify for Accounts Receivable Financing or Factoring
While requirements vary across the factoring industry for net terms financing, you can generally expect:
- A minimum dollar amount in invoices to get paid early.
- Minimum revenue requirements. You’ll often need to provide financials.
- Industry requirements. Some factoring companies only work with certain industries.
- No tax balance, or an established payment plan with the CRA or IRS
- No liens (unless they can be removed)
- Invoice other businesses or government agencies.
- Invoices for completed work that are less than 90 days old.
- Creditworthy customers. Your customer’s creditworthiness is more important than your own.
The Best Accounts Receivable Financing and Factoring Companies
Factoring Company | Key Points | |
FundThrough |
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eCapital |
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1st Commercial Credit |
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Ready to Get Your Invoices Paid Early?
FAQ: Explore Accounts Receivable Financing & Factoring with FundThrough
How does FundThrough’s accounts receivable factoring work?
Start factoring your accounts receivable with FundThrough in three simple steps:
1. Create your account & underwrite your company Sign up for your free FundThrough account or optionally sync your QuickBooks to automatically pull in eligible invoices and business information. We’ll underwrite your company with this data, basic documentation, and additional info as needed through the process. |
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2. Underwrite your customer & send NOA We’ll verify the invoices you choose for early payment and underwrite your customer to give you peace of mind about your payments. We’ll work with you to send your customer an NOA and redirect payment to FundThrough. |
3. Get paid and get growing You’ll see payment in your linked bank account the day after full approval and acknowledgement of the NOA. We’ll handle your accounts receivable and inform you when your customer pays their invoice. |
For more on this topic, see how it works.
What are the benefits of using FundThrough for invoice factoring?
FundThrough provides all the typical benefits of factoring services and more, such as:
- No long term contracts with minimum required funding volume
- Choose invoices for funding (aka spot factoring)
- Unlimited funding
- 100% advance rates
- No hidden fees; transparent pricing
- Dedicated support
- Simple online application
- Optional QuickBooks and OpenInvoice integration
- No long-term commitments after your customer pays the invoice
- Same day funding available (after first funding)
- Professional treatment of your customers
- 4.6 stars on Google Reviews
- Named Best Overall Factoring Company 2025 by Forbes Advisor
What industries partner with FundThrough for AR Financing?
We can work with most industries except for real estate and construction. A few examples of industries that we work with a lot include:
- Oil and gas
- Wholesale
- B2B retail
- Food suppliers
- Staffing
- Manufacturing
- IT and technology companies
- Professional services
- Government contracting
How does FundThrough compare to other accounts receivable financing and factoring companies?
FundThrough differs from other accounts receivable financing and factoring companies by offering:
- A tech-powered platform for that makes funding quick and easy with AI and automation
- Unlimited funding, for as much as you have in eligible invoices
- No hidden fees; we only charge one flat fee
- 100% advance rates, to provide your full invoice value (less our fee) upfront
What are the factoring needs for different sizes of businesses?
Different sized businesses will have different needs and use cases for factoring:
- Small businesses. These businesses are the typical customer for factoring since it’s difficult for them to get approved for a loan or line of credit. Small businesses often use factoring to bridge operational cash flow gaps (like payroll) or to grow the business by taking on larger contracts or more jobs overall.
- Medium-sized businesses. Businesses that are medium sized still might use factoring for payroll, materials, equipment, or growth, but they might also get invoices paid early if they can’t get a time-sensitive increase for a line of credit–or if they simply don’t have time to deal with the paperwork and waiting that comes with traditional financing.
- Enterprise-level businesses. When a business reaches enterprise level they typically don’t need factoring because they can easily get approved for bank financing.
What are the tax and legal considerations for factoring?
- How factoring affects your balance sheet: One the advantages of factoring is that it’s not debt because you’ve sold an asset: the future invoice payment. Factoring invoices won’t add liabilities to your balance sheet.
- Tax deductibility of factoring fees:
- In the US: interest fees might be tax deductible, but service fees (examples include origination fee, early contract termination fee, and late payment fees) are not. Your CPA will have the answer for your unique situation.
- In Canada: Interest (a.k.a., the discount rate) is generally deductible as a business expense.
Is factoring the same as receivables financing?
No, factoring involves selling your invoices for immediate cash, while receivables financing is like a line of credit that uses outstanding invoices as collateral to borrow against.
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.