Mike, a small commercial painting/drywall contractor, found himself in a tight spot. Despite completing projects on time and having a great client reputation, he struggled to make payroll due to the extended client payment terms. When researching his options he had heard about AR financing and AR factoring but was unclear which is the best to help him through his cash flow gaps. If you too are wanting to learn about these two choices and their benefits, this guide is for you.
Contents:
– What is Accounts Receivable Financing?
– What is Accounts Receivable Factoring?
– The Difference Between AR Factoring vs. AR Financing
– The Pros and Cons of Each
– Which is Best for Your Business?
What is Accounts Receivable Financing?
Similar to a traditional loan, AR financing (also known as invoice financing), allows a business to borrow money using the value of outstanding invoices as the collateral. After your client pays the invoice, you pay the AR Financing company back.
The typical fees charged are 1% to 5% of the invoice amount. The percentage rates are often tied to how much time you need before repaying the AR Financing company, your credit history, and the amount needing to be funded.
What is Accounts Receivable Factoring?
AR factoring (or factoring for short) involves selling your outstanding invoice or invoices to a third-party company, known as a Factor. The AR Factoring company then collects payment directly from your client.
When they purchase your invoice(s), the Accounts Receivable Factoring company will advance you up front a percent of the invoice amount, typically 70% to 90%. After receiving payment, they will return the remaining 10% to 30% to you, less their fees.
What is the Difference Between AR Financing and AR Factoring?
Both options have their merits depending on your company’s situation. If you have good credit and the time to be approved, AR financing might be the way to go. However, if you need funds quickly and have limited (or no) credit history, AF factoring would be the better choice.
Pros and Cons of Accounts Receivable Financing
- Pros: Lower interest rates than factoring, you retain control of your invoices.
- Cons: Like with most loans, financing can be slow to get, you will need an established credit history, the responsibility of collecting payment remains with you.
Pros and Cons of Accounts Receivable Factoring
- Pros: Much faster application/approval time, your client’s credit rating is used so often easier to get, keep your extended payment terms with clients.
- Cons: Usually higher interest rates, the factoring company might communicate directly with your client about payment.
>> RELATED READING: The Pros and Cons of Invoice Factoring — Extensive List
So, Which is Best for Your Business?
Now that you understand the difference between both AR Financing and AR Factoring, one option should stand out as “the one”. If you believe factoring is the right option for your business, you will now need to know how to compare factoring companies. The easiest would be to check out our guide titled: How to Pick the Best Factoring Company. If you’re convinced that CapitalPlus, with its 25 years of experience supplying AR financing to the construction industry, is best for your business, give us a call (or schedule a callback) to get started.
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