At some point, you may have run across the idea of accounts receivable funding by a traditional bank. Although both accounts receivable financing and factoring can be used to access funds quickly for working capital, they are not the same thing. Banks do not normally offer true accounts receivable factoring since they do not buy the invoices, but use them as collateral for a loan. Here are the key differences in the two accounts receivable methods.
Factors Buy, Banks Loan
The primary difference between factoring and bank financing with accounts receivables involves the ownership of the invoices. Factors actually buy your invoices at a discounted rate, while banks require you to pledge or assign the invoices as collateral for a loan. Similar to a factoring company, the bank analyzes your existing accounts receivable and chooses the ones they will accept as collateral. If they do not like the customer’s terms of repayment or if the customer pays too slowly, they will not count those accounts receivables as collateral. The factor also examines your accounts receivables and is normally more lenient on the ones they accept, but they will typically charge slightly higher fees on the invoice payments 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 repercussions depending on your current debt situation.
Factors Pay 97% to 99%, Banks Loan Only 75% to 85%
The factor will advance you around 75% to 95% on the invoices they factor and hold the other 25% to 5% in reserve. The factor pays you back the reserve as your customers pay their invoices. Typically, you end up with 97% to 99% of your total accounts receivables after all payments are collected and the 1% to 3% factoring fee is taken out. 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 traditional business bank loans.
Factors Can Take on the Responsibility of Collecting Payments on the Invoices; Banks Leave that Responsibility to You
Since the factoring company has purchased your invoices, they now have the responsibility to collect the payments. This allows you to save money by not having to pay your own employees to manage the accounts receivable process. On the other hand, the bank does not perform any accounts receivable tasks, so you have to use and pay your staff to collect on the invoices. In many cases, the factoring company also provides you credit protection. This means the factor, not you, takes the hit if a customer does not pay or goes bankrupt before the invoice is paid. Of course, you have no credit protection with the bank since you still own the accounts receivable invoices.
You can use either of these financing methods to operate your business more effectively. If you are considering either option and need more information, contact us and we can help you weigh the pros and cons based on the details of your business situation.