The difference between AR Financing and Invoice Factoring is small but critical. Its difference is so small that many tend to use the terms synonymously. Confusion is common because the essential component of acquiring funds in both the options is the company’s “Accounts Receivable.”
Accounts Receivable Financing or AR Financing refers to the total money owed to a company by its B2B or B2G customers. Invoices are the individual bills that make up a company’s accounts receivable (AR).
When a seller sells goods or services to their customers, they issue an Invoice to their customers. The amount due on the invoice is added to the company’s open Accounts Receivable, which is classified as a current asset on the balance sheet of the seller.
What is Accounts Receivable Financing or AR Financing?
Accounts receivable financing is a kind of asset-based lending where a company uses its receivables. These are outstanding invoices by its B2B or B2G customers — as collateral in a financing agreement.
In this agreement, an accounts receivables financing company or bank advances to its borrower client some percentage (50-90%) against its eligible unpaid invoices or accounts receivables. The borrower will complete a borrowing base certificate, which computes both its eligible and ineligible AR (Accounts Receivable). Computation of this certification can be daily, weekly, monthly, or quarterly; depending on their significant needs and the company’s financial strength.
What is Invoice Factoring?
Invoice Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (invoices) to a third party (called a factor) at a discount. The objective of this action is to meet urgent cash needs and to mitigate credit risk (if non-recourse factoring).
What are the Differences between AR Financing and Invoice Factoring?
- A significant difference in Invoice Factoring is that you sell AR invoices rather than offer it as security. Technically, it is not a loan but a sale of a financial asset. On the other hand, AR financing is a loan where a company’s assets in the form of invoices are pledged.
- Factoring is usually (but not always) more expensive. That’s due to the factor having the receivable as the only source of payment. Many consider this as riskier and more operationally intensive. Thus, the price is higher. AR loans tend to be less expensive because the lender has the AR collateral and a claim against the borrower.
- Invoice factoring is more flexible as compared to AR financing. Under factoring, you can choose which invoices to sell to the factor, whereas; in AR financing, you need to present all your accounts receivables as collateral.
- It is comparatively easier to qualify for Invoice factoring and with a minimum, monthly sales of only $5000. To be eligible for AR financing, it usually requires a minimum of $75,000 a month in sales. Consequently, Factoring is ideal for the new and financially challenged company. AR financing may not be available to a very small or weak financially company.
- Another difference is that in Invoice Factoring, factors take the responsibility of collecting payments. In AR financing, the burden of managing payments still lies with you. You still have to deal with customers and bear bad debts, if any. At ARFunding.org, we offer credit protection, so the risk of your customer filing bankruptcy falls on us. Also, if you have client concentration, invoice factoring is an option, while many AR Financing companies will disqualify you with high client concentration.
- Under Invoice factoring, the factor performs a credit check on your customer and deal with its accounts payable department. However, this is not the case with AR Financing.
So if you are a newer, smaller business; Invoice factoring is available from day one, including Credit Protection. More established companies with strong balance sheets and their credit department can qualify for A/R Financing.