Accounts receivable financing vs factoring

Accounts receivable financing and factoring are two receivables financing methods, both able to help companies optimize their working capital position. Here’s a guide to their differences and similarities.

Cash flow, or the movement of money into and out of a business, is a major determining factor in overall operational health. Businesses need sufficient cash flow to cover everything from payroll to inventory purchases. Positive cash flow also enables companies to invest in growth initiatives or build resilience by providing a buffer against unexpected financial challenges.

Increasing cash flow by speeding up capital inflows is, therefore, a priority for lots of businesses. Accounts receivable financing solutions can be a helpful tool in achieving that goal.

Accounts receivable (AR) represents the total value of a company’s outstanding invoices – in other words, money owed to the business for products or services sold but not yet paid for.

The average US business has 24% of its monthly revenue tied up in accounts receivable. The quicker these receivables can be realized as revenue, the quicker the business can use the money. Accounts receivable financing and factoring are two methods of expediting that process.

Here’s everything you need to know about AR factoring and AR financing, two of the most popular ways to optimize working capital and release liquidity locked away in unpaid invoices.

Accounts receivable financing explained

Accounts receivable financing (sometimes referred to as invoice financing) allows businesses to receive immediate funding based on their outstanding customer invoices. Some or all of the company’s AR is issued as collateral to secure a loan from a third-party financer or funder.

In an AR financing arrangement, the borrower can decide how many invoices it wants to secure financing against. Interest is charged on the amount lent, which is typically between 70% and 80% of the total value of the invoices.

The borrower retains ownership of the invoices they’ve raised funding against and, therefore, remains responsible for collecting payment. When the customer pays the invoice, the borrower repays the amount borrowed to the financer.

Since the borrower maintains ownership and responsibility for the collection, they have full control over the collections process and can keep their financing arrangement discreet if they choose to.

Accounts receivable factoring explained

Accounts receivable factoring (also known as invoice factoring) is a similar form of financing whereby, instead of using accounts receivable as collateral to secure

a loan, businesses can outright sell their unpaid invoices to a third-party financer, called the ‘factor’.

Typically, the business initially receives between 70% and 90% of the value of the invoices. The factor then sends the remaining amount (less factoring fees) when it collects payment from the business’s customers at the due date.

Since factoring involves selling accounts receivable outright, the business is no longer responsible for collections when the invoices fall due. That means accounts receivable factoring arrangements can’t be kept from customers, as the factor will communicate directly with them to collect the payment.

Why supplier diversity is important

The case for supplier diversity isn’t just an ideological one, though. Plenty of evidence supports the potential benefits of broadening the diversity in your supplier base.

According to a survey by PwC, for example, 91% of business leaders believe their company has a responsibility to act on ESG issues. And 86% of employees prefer to work for companies that care about the same issues they do.

In another study, McKinsey & Company found that 64% of millennials say they won’t work for companies that perform poorly on corporate social responsibility (CSR).

Both studies reinforce the idea that embracing supplier diversity doesn’t have to be a purely altruistic move. It can have a tangible, long-term impact on your business’s reputation, access to the labor market, and even the bottom line.

Benefits of supplier diversity

By adopting a supplier diversity program, businesses can enhance their CSR/ESG credentials, become more attractive to investors, enhance their status with potential employees, and increase their overall brand appeal.

And this doesn’t necessarily come with a downside, either. According to research from the Hackett Group, virtually all diversity suppliers meet or exceed expectations. The top corporate performers in supplier diversity experience no loss in efficiency and often see improved quality, increased market share, and access to new revenue opportunities.

But that’s not all. Other benefits of supplier diversity include:

Difference between factoring and accounts receivable financing

Accounts receivable financing and invoice factoring are both ways in which a business can generate available cash from the value locked up in its accounts receivable. The principal differences between the two include the nature of the financial arrangement between the business and the financer and the responsibilities of each party when it comes to collecting payment:

• With accounts receivable financing, a business uses unpaid invoices as collateral to secure what is essentially a loan. Factoring, on the other hand, involves selling the invoices outright, meaning that ownership passes to the factoring company.
• Where collections are concerned, a company using AR financing still has complete ownership of its invoices and retains responsibility for collecting payment. With factoring, on the other hand, it becomes the factor’s responsibility to collect payment when the invoices fall due.
• Another difference between the two arrangements is that with invoice factoring, the company is still exposed to the risk that invoices could turn into bad debt if they are not paid. This is not usually the case with a factoring arrangement.

Receivables financing vs factoring

	Accounts receivable factoring	Accounts receivable financing
Financing arrangement	Business sells unpaid invoices to factoring company at a discount	Business uses total value of unpaid invoices as collateral for loan
Invoice ownership	Ownership of invoices is transferred to the factor	Business retains ownership of their invoices
Collections responsibility	The factor is responsible for payment collection	Business remains responsible for payment collection
Payment receipt	Invoice payments are made directly to the factor	Invoice payments are made to the supplier business, as usual
Confidentiality	Financing arrangement can be kept confidential	Financing arrangement is disclosed to customers

How to choose the right form of receivables finance

Since both accounts receivable financing and factoring can be used to free up funds tied up in unpaid invoices via third-party financing, businesses have the freedom to choose between the two options. Some key factors to consider include the following:

• Accounts receivable financing and factoring have different fee structures. Since factoring includes collections as well, it tends to be more expensive and can typically involve several different fees, such as maintenance fees, monthly minimums, and termination fees.
• For some businesses, especially those with limited resources, the credit control and collection service included in a factoring arrangement can be attractive. For others, it is more important to manage the sales ledger and collections process in-house.
• When a third party collects invoices due, customers may interpret this in a negative way. When a company uses factoring as a legitimate method for increasing working capital to fund growth, it may be seen by its customers as a sign of financial difficulty.
• For many companies, the fact that the factoring company acts as an intermediary between them and their customers is a concern. For example, if the factor conducts credit checks and pursues unpaid invoices in an overly aggressive way, it can reflect badly on the business.

Beyond traditional AR financing

Taulia’s Accounts Receivable Financing solution (AR Financing) provides businesses with an off-balance sheet solution that enables businesses to optimize working capital through early payment on invoices while also providing collection services through automated operational processes on our Working Capital Management platform. What’s more, with Receivables, businesses can gain access to a diverse pool of liquidity from multiple funders.

Traditional receivables financing often lacks the required technology to scale effectively. Taulia’s ERP integration, in contrast, means that we can transmit all receivables invoices, accounting entries, and reconciliation information seamlessly to multiple funders – thereby simplifying the process, increasing efficiency, and reducing operational risk.