Understanding the Differences between Accounts Receivable Factoring and Traditional Bank Loans
At some point in your business venture, you may consider the idea of accounts receivable funding by a conventional bank. Even though both accounts receivable factoring and financing can be used to access finances swiftly for working capital, they do not hold the same meaning. Banks do not usually offer true accounts receivable factoring since they do not buy the invoices, but they use them as security for a loan. Here are the key differences in the two methods.
The chief difference between factoring and bank financing with accounts receivable involves the ownership of the invoices. Factors actually purchase your invoices at a discounted rate, while banks require you to guarantee or assign the invoices as guarantee for a loan. Similar to a factoring company, the bank evaluates your existing accounts receivable and decides the ones they will accept as security. If they do not like the customer’s terms of reimbursement or if the customer pays too slowly, they will not count those accounts receivables as security. The factor also examines your accounts receivables and is normally more relaxed on the ones they acknowledge, but they will naturally charge slightly higher fees on the invoice expenses that come in late. Also, since the factoring is not considered a loan, it will not affect your debt utilization or debt-to-equity ratio. Obviously, the bank loan will and this can have negative impact depending on your existing debt situation.
The factor will give you an advance of around 75% to 85% on the invoices they factor and hold the rest in reserve. They pay you the reserve as your clients pay their invoices. Usually, you get 97% to 99% of your total accounts receivables after all expenses are collected and the 1% to 3% factoring fee is charged. Most banks only loan you 75% to 85% of the value of your invoices and they charge you an interest rate on the amount of the loan. This rate is usually higher than other types of business bank loans.
Both the financing methods can be useful to fund your business in an effective manner. It’s better to consult an expert so you can get a clear idea which works for you based on your business situation.