Factoring vs vs Accounts Receivable Financing
Factoring and Accounts Receivable Financing are terms related to financing small businesses. It has always been a difficult task to secure capital to start a venture as banks are not willing to provide capital without asking for collateral or financial statements for the past few years which is obviously not there in case of start up of a small business. Cash inflow is vital for any new small business to sustain it and to meet day to day expenses and business operations. With credit environment being tight more than ever, companies are always looking for alternative ways of financing their business to get the capital that they badly need to keep running it smoothly. Two such non traditional ways of financing a small business are factoring and accounts receivable financing. Often the two are spoken of as being almost identical but there are differences between factoring and account receivable financing that need to be highlighted so that anyone who is looking for finances for his business can take either or both depending upon his requirements.
This is the system of outright purchase of outstanding accounts of any business by a company that specialize in finances. This company is also called factor. Normally a factor advances 70-90% of the total amount of receivables at the time of purchasing receivables. The balance amount is released by the factor after deducting factoring fee when factor realizes the invoices normally after a period of 30-45 days. The factoring fee is dependent upon the number of days in which the money can be realized by the factor and also upon the total value of the receivable. Normally, factoring fee is between 1.5 to 5.5% of the total value of the receivable. Factoring fee goes high when there are some risks involved in realization of receivable.
Factoring provides an easy way of having cash flow in a business which is vital to keep running day to day operations and meeting sundry expenditures. On the other hand factoring companies are flourishing as they are charging commission for collecting receivables from vendors on behalf of the company. In this system a small business owner can choose which invoices to keep for self realization and which ones to give to factoring company depending upon the ease of realization.
Account receivable financing
This is another system of financing a small business which resembles traditional financing from banks but has many subtle differences. While a bank extends business loans only after the owner provides collateral such as fixed deposits, plant and machinery or some other property, in account receivable financing the business owner has to pledge business assets along with accounts receivable to the finance company. The line of credit by the lending institution varies in tune with the receivables and normally the business owner is allowed to withdraw up to 70-90% of the receivables and the interest is charged only on the amount of money withdrawn by the business owner. Account receivable financing is cheaper than factoring and here receivables work as collateral for credit. However, account receivable financing may not be suitable for very small businesses as banks set up a minimum target of monthly sales to allow credit in this manner.