What’s the Difference Between Accounts Receivable Financing and Factoring?
For business owners and financial managers, access to the right credit resources means access to the tools you need to keep your business running during the part of the cycle where you’re waiting on incoming cash or new orders. Understanding your choices means being able to distinguish between them, even when they are very similar, and that’s why you need to make sure you understand the difference between factoring and accounts receivable financing.
Often, they seem like the same thing, especially since factoring is often used as a shorthand term for the other. The truth is, the distinction is less like apples and oranges and more like the distinction between a car and an automobile. Factoring refers to an arrangement that advances cash to a borrower based on the later delivery of payment. It can be used in a variety of different ways, including as a method of financing accounts. It’s not totally accurate to confuse the two, though, because there are other forms of factoring.
Historically, factoring has been used to advance money against mining operations, international mercantile trade, agriculture, and a variety of other business ventures. During the middle ages, fee-based factoring agreements were an ideal way to work around religious usury laws in lands that had religious taboos against charging interest. Since then, they have developed into an alternative to traditional lending. There are several advantages to factoring, some of which are unique to specific forms of it.
Accounts receivable financing is the most common form of modern factoring, but some lenders will also offer purchase order financing options. Financing your accounts means getting a cash advance against outstanding invoices where the work product has already been delivered to the customer. It works similarly to selling the debt, except you wind up with a lot more of the money. Your factor reviews the outstanding accounts and your customers’ payment histories, then offers you an advance. The size of it is based on a few things, including whether you are financing all your invoices or just a selection.
This form of factoring allows you to outsource your collections as well because the factor typically follows up with the customer, processing payment and sending you the remainder after the fees and original advance have been deducted. This makes accounts receivable financing attractive as a credit option because it allows you to access the part of your money you need early, while still counting on your profits when payment does come in.