When it comes to business financing, there are so many specialized products designed to work as the most efficient solution to specific cost scenarios that it can be hard to tell two types apart if their mechanics look very similar to the customer. That’s why many companies and even some lenders confuse accounts receivable financing and factoring. It’s important to understand why they are different, what each offers, and why financing receivables often turns out to be the better option for everyday cash flow management.

Financing Receivables for Cash Flow

When you finance your invoices, you’re getting a cash advance against their value. Typically, it’s somewhere below 85% of the face value, and it can be as low as 60% in some cases. Most people fall somewhere between the two. Your customers’ credit and payment history might be used to weigh the risks of the advance running over its projected repayment date, but it’s rare for your own business credit to come into play with this type of financing. Your lender will need you to assign repayment collection to them, and that means you’ll need to let your customers know about the situation. Clear communication is essential here, because you still own the invoice and receive the payment after your advance and the lender’s fees are deducted. Customers can feel alienated if an invoice is sold when it is not late, so communicating that it is not late and another party is simply receiving payment can help put minds at ease among your regulars.

Factoring Invoices To Streamline Receivables

Factoring also involves taking a cash payment that is a substantial percentage of the face value of your invoices, but when you factor them you move them off your books. It’s essentially selling the debt to the factor in this scenario, which means the factor faces all the risk if the account goes unpaid. As a result, it’s often the best solution for late invoices if you are losing confidence in the customer repaying within a reasonable time. The trade-off is that the less likely a fast turnaround looks to be, the lower the percentage of the face value you will receive. The chance of alienating clients under this scenario is higher, too, because once you relinquish those invoices to a factor you are no longer entitled to transparency about collection practices or communications with clients.

Often accounts receivable financing is the less expensive option, but if you need cash and you also need to move invoices off your accounts department’s plate, factoring provides an elegant solution. The key is understanding which of the two fits the situation with your current batch of invoices.