Invoice factoring and accounts receivable financing can help small businesses boost their cash flow.

Both invoice factoring and accounts receivable financing can offer significant benefits by providing upfront funds for your business.

As a business owner, you understand the importance of a healthy cash flow to drive success. But if it takes months to receive payment for work you performed or products you delivered, your working capital could be negatively affected. Fortunately, solutions are available to help you free up money in the short term: invoice factoring and accounts receivable financing.

Let’s take a closer look at each working capital financing option to determine which one best suits your small-business needs.

Accounts Receivable Financing?

What Is It?

Accounts receivable financing, also known as invoice financing, is an excellent working capital financing solution for businesses that sell on credit and need a quick cash flow boost. It serves as an alternative to a traditional line of credit and can be highly beneficial for businesses that:

  • Are on target with steady growth or expansion
  • Have seasonal interruptions in cash flow
  • May not qualify for a traditional loan from a financial institution

How Does It Work?

With accounts receivable financing, a specialized financing company will advance you a percentage of the value of your outstanding receivables, often up to 90%. Here’s how the process works:

  1. You have outstanding invoices from customers totaling $10,000.
  2. You work with an accounts receivable financing business and present your invoices as collateral.
  3. The accounts receivable financing business offers you a percentage of the invoice value as an advance –
    90%, or $9,000.
  4. You repay the advance in regular installments over a 90-day period, with an annual interest rate of 25%. Your weekly payment is approximately $716.
  5. Throughout this process, you retain control over collecting payments from your customers and manage your relationship with them.
  6. The accounts receivable financing company charges interest as long as they are owed money against your invoices. Ultimately, the total interest paid would be around $300.

Accounts Receivable Factoring

What Is It?

Accounts receivable factoring, also known as invoice factoring, is another solution for businesses that sell on credit and need to enhance their cash flow.

Factoring is particularly useful for businesses that:

  • Face challenges with slow-paying customers
  • Have seasonal interruptions in cash flow
  • Aim to grow and expand
  • Are startup businesses looking for additional funding

How Does It Work?

A specialized company will purchase your outstanding invoices in exchange for a lump sum, which is usually a percentage of the total invoice value. Here’s how it would work:

  1. You have unpaid invoices owed by customers worth $10,000.
  2. You work with an accounts receivable factoring company that purchases these invoices from you.
  3. You agree to pay the factor a 4% fee on the total invoice value ($400).
  4. Of the remaining $9,600, the factoring company forwards you 80% of the value, which is $7,680.
  5. The factoring company handles the collection of payments and manages interactions with your customers, including handling payment requests and late fees.
  6. After the invoices are settled, the factoring company sends you the remaining amount, $1,920.

Accounts Receivable Financing vs. Factoring

What’s the Difference?

The main distinction between accounts receivable financing and accounts receivable factoring lies in how you receive the money. In accounts receivable financing, you take a loan against the outstanding invoices’ amounts, while in accounts receivable factoring, you sell your invoices to the factor.

Accounts receivable financing allows you to get a loan for up to 90% of the full outstanding amount, while receivable factoring typically provides 70% to 90% of the amount owed.

These services are specifically tailored to businesses that face delays in receiving invoice payments. If your business receives payment before providing goods or services or if you receive immediate payments, these options may not be suitable for you. However, if your typical customer payment cycle involves weeks or months, these services can bridge the cash flow and financial gap between invoicing and receiving funds in your bank account.

Which Is Right for Your Business?

Both accounts receivable financing and accounts receivable factoring provide considerable advantages by offering upfront funds for your business. They both contribute to enhancing cash flow, especially when timing is critical.

Accounts receivable financing might be a good fit if:

  • You prefer making regular payments.
  • You want to maintain control of the payment process.

Accounts receivable factoring may be a better option if:

  • You’d rather delegate payment collection to another company.
  • You want the amount you owe to be deducted from the business’s owed amount, and you receive the remaining sum, minus a fee, when customers pay.

Keep in mind that both accounts receivable financing and accounts receivable factoring can be more expensive than a traditional loan or line of credit from a financial institution.

Understanding Your Options

Both accounts receivable financing and accounts receivable factoring can be valuable tools for enhancing your cash flow. To determine the best option for your business, consider your credit profile, the size of your invoices, and your specific financing needs. Additionally, you may want to explore other financing options like small business term loans and lines of credit to further support your growth and success.

Take the Next Step

Ready to learn more? Consult your financial institution today.

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