What You’ll Learn:
- The difference between AR financing vs. factoring
- Which solution is better for your company
Small business owners know how crucial cashflow is—timely payments from your customers keep everything else running smoothly. Accounts receivable (AR) financing and invoice factoring are two tools business owners can use to access funds from unpaid invoices right when they need it.
Comparing AR financing vs. factoring can be confusing since the terms are so similar. Here are some of the key differences to keep in mind.
Key differences between AR financing vs. factoring
AR financing is a loan that uses your invoices as collateral; factoring involves selling your invoices to a third party. Both give you the benefit of upfront cash, but the processes are different. Learn more about the key distinction between how AR financing works and how invoice factoring works.
Ownership of receivables
When your business uses AR financing, you retain ownership over the invoices involved. You’re responsible for collecting on them and maintain full liability for the accounts receivable. With factoring, the factoring company takes ownership of the invoices. They handle customer communication and collections.
Depending on whether they engage in recourse or non-recourse factoring, you may still retain some liability for the invoices until they are paid in full. Recourse factoring puts the responsibility of invoices back on you if the customer does not pay them. Learn more about how to account for factored invoices here.
Control over customer relationships
AR financing is a loan, meaning the financing party does not become involved with your customers. You manage your own collections and relationships; no one else contacts your customers.
When you use factoring, the factor usually takes over collections. Your customers receive a notification when you sell their invoice, and they pay the factoring company directly going forward. This can sometimes impact customer relationships, as customers may dislike the experience of working with a factoring company or the change in process. They may also see the factor as a sign of financial issues with your company.
Risk of non-payment
Business owners are familiar with the frustration of non-payment. It’s a risk that comes with any invoicing process. With AR financing, you maintain the full risk of non-payment. Your receivables are only collateral for the loan.
With factoring, the amount of risk and ownership of risk depends on whether your agreement is recourse or non-recourse. The factoring company assumes full responsibility for risk in non-recourse factoring. However, with recourse factoring, your business retains much of the risk because you must buy back the unpaid invoices if the customer does not pay.
Fee structures and costs
How much does AR financing cost? Financing is generally cheaper than factoring. The costs come from interest on borrowed funds, similar to other types of loans.
Factoring takes a percentage of each invoice—typically 1% to 5% of the total amount—and can come with additional daily processing fees that add up over time.
Speed of cashflow
Factoring typically gives you quicker access to cash than financing does. Eligible invoices may be processed for sale in a single business day in many cases. AR financing is slightly slower, as it involves a loan application and approval process, though it is still faster than traditional loans. You can get approved in just a few days.
Eligibility and credit requirements
Credit checks are involved for both financing and factoring. The difference is who has their credit checked. With AR financing, lenders consider both the creditworthiness of your business and the creditworthiness of your customers. They must find both parties to have acceptable credit histories in order to issue a loan.
Factoring companies typically only look at the credit history of your customers. You can still sell your invoices even if you are a new business, a small business with limited credit history, or a business with struggling credit. As long as your customers’ credit history indicates a likelihood of paying their invoices, the factoring company will typically approve them for purchase.
Which is better: AR factoring or AR financing?
With these differences in mind, how do you choose which is best for your business?
AR financing tends to be ideal for businesses wanting to retain full control over their customer relationships and collections process. If you are comfortable assuming the risk of non-payment, financing also has lower fees. More established companies may be better positioned to manage their debt in this way.
Factoring can be a convenient solution for businesses who need immediate cash and who do not qualify for traditional credit options. It’s more common for smaller or rapidly growing companies who need quicker cashflow.
An alternative to factoring and financing: Hopscotch Flow
Hopscotch Flow is your superior factoring option. This product provides businesses with an alternative to traditional accounts receivable factoring and AR financing companies. With Hopscotch, you get to maintain your customer relationships and have access to quick cashflow at the same time.
Nothing changes on the customer’s end. On your end, Flow advances 90% of an invoice amount without any credit checks. Learn more about the process and get paid faster with Hopscotch Flow.
Bret Lawrence
Writer
Bret Lawrence writes about invoicing and cash flow management at Hopscotch. Her previous roles include senior financial writer at Better Mortgage, where she covered lending and the home buying process. Her writing is not financial advice.
