Financing Receivables vs Trade Receivables: A Comprehensive Guide

When it comes to managing cash flow and enhancing a company's financial position, business owners have several alternative financing options at their disposal. Two popular options are invoice factoring and accounts receivable (AR) financing. While they may seem similar at first glance, there are key differences between the two that every business owner should be aware of.

What is Invoice Factoring?

Invoice factoring is a financing solution where a business sells its outstanding invoices to a third-party company, known as a factor. In return, the business receives an immediate cash advance, typically around 80% of the invoice value. The factor then collects payment from the customers and deducts a fee for their services before remitting the remaining balance to the business.

How Invoice Factoring Works

Invoice factoring is a relatively straightforward process:

1. The business provides the factor with copies of its outstanding invoices.
2. The factor advances a percentage of the invoice value to the business, typically around 80%.
3. The factor takes over the collection process and contacts the customers for payment.
4. Once the customers pay, the factor deducts their fee and remits the remaining balance to the business.

What is AR Financing?

AR financing, also known as trade receivables finance, is a funding solution that allows businesses to leverage their accounts receivable for working capital. Instead of selling the invoices outright, the business uses them as collateral to secure a revolving line of credit from a lender. The business can then draw funds from this credit line as needed, based on the value of its outstanding invoices.

How AR Financing Works

AR financing involves the following steps:

1. The business applies for an AR financing facility with a lender.
2. The lender reviews the business's accounts receivable and approves a revolving line of credit.
3. The business can draw funds from this credit line as needed, based on the value of its outstanding invoices.
4. The business pays interest and fees on the funds it borrows.

Accounts Receivable Financing vs. Factoring

While both invoice factoring and AR financing involve leveraging accounts receivable for funding, there are several key differences:

• Ownership of Invoices: In invoice factoring, the business sells its invoices to the factor, transferring ownership. In AR financing, the business retains ownership of the invoices and uses them as collateral.
• Control of Collections: In invoice factoring, the factor takes over the collection process and deals directly with the customers. In AR financing, the business maintains control over collections and is responsible for collecting payments from its customers.
• Cost Structure: Invoice factoring involves a fee deducted by the factor, which can vary based on factors such as invoice value and customer creditworthiness. AR financing, on the other hand, typically involves interest and fees based on the amount borrowed from the credit line.

Why Do Companies Use Invoice Factoring?

Companies may choose invoice factoring for several reasons:

• Immediate Cash Flow: Invoice factoring provides businesses with immediate cash flow by converting outstanding invoices into cash.
• Outsourcing Collections: By partnering with a factor, businesses can outsource the collection process and focus on core operations.
• Flexibility: Invoice factoring allows businesses to access funds without taking on additional debt.

Which Option is Best for Your Company?

The choice between invoice factoring and AR financing depends on various factors such as business needs, cash flow requirements, and the level of control the business wants to maintain over collections. Consulting with a financial advisor or exploring multiple financing options can help businesses make an informed decision.

What Does AR Stand for in AR Financing?

AR stands for accounts receivable in AR financing. It refers to the money owed to a business by its customers for goods or services provided on credit.

Good Fit for Invoice Factoring?

Invoice factoring can be a good fit for businesses that have a large volume of outstanding invoices and need immediate cash flow to support their operations.

Good Fit for AR Financing?

AR financing can be a good fit for businesses that want to maintain control over collections and have ongoing working capital needs.

How do the fees compare?

The fees for invoice factoring and AR financing can vary based on factors such as invoice value, customer creditworthiness, and the specific terms of the financing arrangement. It is essential for businesses to carefully review and compare the fee structures of different financing options before making a decision.

Answering Your Questions

Business owners often have questions about financing receivables and trade receivables. Here are answers to some common questions:

• Can invoice factoring help improve cash flow?
  Yes, invoice factoring can improve cash flow by providing businesses with immediate funds to cover their expenses and invest in growth.
• Does AR financing require a minimum volume of invoices?
  AR financing does not typically require a minimum volume of invoices. However, lenders may have their own eligibility criteria, such as a minimum revenue threshold.
• Can businesses use both invoice factoring and AR financing?
  Yes, businesses can use both financing options depending on their specific needs and circumstances. For example, a business may use invoice factoring to address immediate cash flow needs and AR financing for ongoing working capital requirements.

Search

Browse by Topic

Turn your outstanding invoices into cash.

Turn your outstanding invoices into cash

Lending Options

About

Resources

Disclosures

Industries

Customers

If your business sells on credit or open account terms, trade receivables finance can offer a dynamic and flexible solution for managing working capital and enhancing a company's financial position

The basics

Common forms of receivables finance products

Why do companies consider receivables finance?

Key considerations for corporate treasurers

You may also like