The difference between AR Financing and Invoice Factoring is small but critical. It’s different is so small many tend to use the terms synonymously. Confusion is common because the key component to obtain 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 listed as a current asset on the balance sheet of the seller.
Here are the definitions of both AR Financing and Invoice Factoring:
What is Accounts Receivable Financing or AR Financing?
Accounts receivable financing is a type 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 critical needs and the company’s financial strength.
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 immediate cash needs and to mitigate credit risk (if non-recourse factoring).
- One of the major differences is that in Invoice Factoring, you sell accounts receivables invoices rather than offer it as security. So 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 accounts receivable 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 also 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 submit 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 qualify for AR financing, it usually requires a minimum of $75,000 a month in sales. Consequently, Factoring is ideal for 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 whereas in AR financing the responsibility of collecting 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 businesses with strong balance sheets and their own credit department can qualify for A/R Financing.