When your cash flow does not meet your working capital and growth requirements, you can turn to financing through factoring or asset-based lending for a solution.
Many of your customers delay payment on their invoices for 30, 60 or even 90 days – putting a strain on your business’s ability to meet its own financial obligations. Factoring and asset-based lending (ABL) are two solutions that can help you quickly replenish your cash flow.
Both of these financing types can provide you with immediate funds to meet your cash flow needs. But there are some significant differences between the two that you should understand before committing to one versus the other:
In factoring, the factoring firm or “factor” purchases your firm’s receivables at a discount and provides you with an advance of typically between 75% and 90% of the face value of the receivables being factored. The difference between the invoice value and the advance includes both a reserve held against final payment by your customer plus a fee for providing the financing. The reserve is released to you after your customer pays the invoice.
Factoring is based on your customers’ creditworthiness. The factor reviews the finances and credit history of each customer whose invoice you submit for factoring. It does not rely on your firm’s financials.
In asset-based lending, by contrast, you borrow against the assets of your firm, which, like factoring, also typically involves receivables but may also include other assets as well, including inventory of finished goods, raw materials, equipment, real estate or even patents. Your firm’s assets, financials, and creditworthiness – rather than your customer’s credit standing — are the major determinants of whether and how much you will be able to borrow, and at what interest rate.
Because an asset-based loan is collateralized, and the loan is based on the borrower’s financial condition, this type of financing is typically more suitable than factoring for well-established companies with a more sizable base of assets.
By contrast, factoring is more suitable for firms that are less well-established or whose financials are not as strong, but whose customers have a good credit record. Factoring is particularly well-suited for startups and rapidly-growing companies that do not have a large asset base.
Both factoring and ABL facilities are more costly than traditional bank borrowing, but these financings are usually easily and quickly accomplished.
Benefits of Factoring
The use of factoring provides a wide range of benefits. These include:
- Immediate access to cash. The factoring process can often result in delivering funds to your firm within 24-48 hours of your submitting invoices for approval, following an initial startup application period of about 5-10 days.
- You get cash flow without adding debt to your balance sheet. That strengthens your financials, such as your all-important debt-to-equity ratio.
- Factoring terms are flexible. For example, there are no long-term contracts; you decide which invoices you wish to factor and how often you want to use the factoring facility. Furthermore, you can choose to increase the amount of factoring you do as your business grows.
- Factoring fees are reasonable. Fees can be quite low as a percentage of invoice value. They do vary by industry, number and dollar volume of invoices submitted, advance rates, and the credit ratings of your customers.
- You can use the funds from factoring in any way you choose. Factoring firms do not set requirements on how or what you spend the funds on. For example, you can use the funds to enhance your bottom line or fund investment in growth. The immediate cash can help you take advantage of early-payment discounts, obtain discounts from suppliers, or invest in marketing and sales staff to expand your business.
- With factoring, you get professional receivables management. This can save time and in-house costs for collections, and help increase the turn time on your receivables.
Benefits of Asset-Based Lending
While asset-based lending provides some of the same benefits as factoring — e.g., quick access to funding and flexibility in the use of the funds — ABL offers some benefits not provided by factoring.
- For example, even though most asset-based lenders prefer receivables as collateral over other types of assets, they may also lend against inventory, equipment, raw materials, real estate or even patents.
- The costs of ABL may be less than on receivables factoring because of the collateral supporting the loan, but not necessarily. Fees can vary widely between factoring firms and ABLs, and often among different ABL lenders.
If you need to speed up your firm’s cash flow, and you do not qualify for a bank borrowing for any of a variety of reasons, you should consider factoring or asset-based lending. Sometimes, the same financing firm will provide both types of financing. In addition, some factoring agreements may include ABL-like features and vice versa. Therefore, it is important to carefully evaluate all ABL and factoring proposals very carefully, and to conduct due diligence on the financing firm before making your decision.
Lew Koflowitz is an associate of a factoring company in New York City. With an MBA from Columbia Business School, Lew is a financial professional with experience in financial journalism, marketing communications and economics, as well as extensive experience within the financial services industry.