A long-term loan isn’t always the best fit for your business needs. There are times when alternative financing methods, such as a business line of credit or a merchant cash advance, provide the infusion of capital you require for immediate purchases.
Two common ways to obtain fast financing with minimal hassle are accounts receivable financing and invoice factoring. Both methods involve receiving money in advance instead of waiting for clients to pay invoices 30 or 60 days after the sale is made. If you have an urgent need of funds, such as for annual taxes, payroll or business emergencies, then these options can be a perfect solution.
What Is the Difference Between Accounts Receivable Financing and Invoice Factoring?
While the principle of the advance payment is the same, these two types of financing work somewhat differently. The best choice depends on your business needs and your personal preferences as an owner.
Accounts receivable financing, also known as A/R financing, involves using your company’s assets as the collateral for a loan. As with other loans, you only pay interest on the amount borrowed. The amount of capital your company qualifies for is determined by the value of accounts receivables and cash flow.
In factoring, you sell invoices to the lender, or factor, in exchange for a portion of the total invoice amount in advance. Your contract with the factor determines issues such as how much money you get up front, how much after customers pay, which company handles collection duties and what the total interest rates are.
What Are the Advantages of Accounts Receivable Financing?
Specific lenders offer perks that may be a great fit for your company. In the case of accounts receivables, taking out a loan provides several advantages, including the freedom to interact with your customers, better interest rates than factoring and transactions that are kept off the balance sheet. If you worry about a third-party calling your customers to collect unpaid bills, then this option is probably a better fit.
When Is Factoring a Good Choice?
Factoring gives your business greater flexibility when it comes to deciding which invoices to sell for a cash advance. The process is fast and easy. Fees are calculated per invoice, which may make bookkeeping simpler for small businesses.
Compared to traditional term loans and A/R financing, invoice factoring has higher interest rates. However, it is much easier to quality for this type of loan if you have less-than-perfect credit since you’re essentially selling items of value to lenders. This is helpful for startups and companies facing emergency capital needs.