A regular bank loan requires taking on debt and has a strict schedule for when you should repay the borrowed money. When it comes to factoring, the factoring company prepays your bills (at a discount), so you're paid for what you're already owed. The main difference between factoring and bank financing with accounts receivable has to do with the ownership of invoices. In fact, factors buy your bills at a reduced rate, while banks require you to pledge or assign invoices as collateral for a loan.
Like a factoring company, the bank analyzes your existing receivables and chooses the ones it will accept as collateral. If they don't like the customer's payment terms or if the customer pays too slowly, those receivables won't count as collateral. The factor also examines accounts receivable and is generally more lenient with those they accept, but will normally charge slightly higher fees on bill payments that are delayed. In addition, since factoring is not considered a loan, it will not affect debt utilization or the debt-to-equity ratio.
Obviously, a bank loan will, and this can have negative repercussions depending on your current debt situation. Like accounts receivable financing, invoice factoring advances your company's money based on the amount of outstanding invoices. However, with factoring, you sell your outstanding invoices to the factoring company (a “factor”) and the factor collects bill payments directly from your customers. Unlike accounts receivable funding, your company doesn't receive 100% of the invoice amount.
When comparing factoring to traditional funding, you may realize that bank loans are sometimes less advantageous in the long term. You could end up paying more for access to that capital than you would with factoring, and it will add responsibility to your company's balance sheet. First, we must understand the fundamental difference between lending and factoring. With loans, you get a loan and use accounts receivable as collateral.
With factoring, you sell accounts receivable for immediate cash. With a loan, you create a liability on the balance sheet that affects leverage and other financial ratios in a potentially negative way. Factoring does not create a liability, since accounts receivable are sold and the asset is converted into another asset (cash); therefore, there are no changes in liabilities and there is no effect on leverage. Most invoice factoring institutions strive to ensure that their customers receive funding within a day or two of approval.
The interest costs associated with these loans can often be lower than those charged by factoring or accounts receivable financing companies. Once the factor collects the full amount of the invoice, the company receives the rest of the balance minus the factor fees. While with factoring, the usual deadline for obtaining a response is usually a couple of days, with the possibility of accessing the availability of funds in the same working week. In this sense, a major misconception with factoring is that customers must be “major top-tier accounts”.
Factoring fees can be quite high and can include a percentage of the value of the bill plus service charges, origination fees, credit check fees, and more. So is invoice factoring better than bank loans? It depends on what stage of development your company is in. The rates vary depending on the amount and amount of your bills, the sector in which you operate, whether you have applied for previous loans, the creditworthiness of your customers and several other factors. Factoring allows a company to do what it does best, and that is to provide the quality product or service it has developed.
Banks don't usually offer true accounts receivable factoring, since they don't buy invoices, but use them as collateral for a loan. .