Difference Between Factoring & Accounts Receivable Financing
It takes money to keep a business running. Payroll, rent and utilities must be paid. When payments on customer invoices are late, it is sometimes necessary to turn to other means to keep money flowing into the company. Two of those options are factoring and accounts receivable financing.
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Definition: Factoring Financing
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When a company factors its receivables, it is selling the receivable, which is money owed by a customer for goods or services provided on credit. The factoring company purchases the receivables and becomes the new owner. The amount advanced by the factoring company is usually 70 to 90 percent of the amount invoiced. When the invoice is paid, the factoring company releases the balance of the invoice, less its fee.
Definition: Accounts Receivable Financing
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For accounts receivable financing, a business works with a financial institution to set up a revolving line of credit, using the receivables as collateral. The business still owns their receivables. The line of credit varies as the receivables vary, with typically 70 to 90 percent of the value set up against which the business can draw funds. Typically interest is charged only against funds actually used.
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Pros and Cons of Factoring
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A negative aspect of factoring is that the invoice is purchased at a discount. However, factoring allows some flexibility because the company selling the receivables can decide which receivables to sell. With fees determined by invoice, it is easy for the business to track the factoring costs. And since the factoring company owns the invoice, it follows up with customers who are past due.
Pros and Cons of Accounts Receivable Financing
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Accounts receivable financing usually costs less than factoring. Because it works as collateral on a line of credit, it is usually simple to move from accounts receivable financing into a more traditional line of credit. However, accounts receivable financing might not work for small companies since there is usually a requirement on minimum monthly sales.
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