Before a company makes a decision about financing, it’s important for the owners and managers to weigh the advantages and disadvantages of both invoice factoring and business loans. Until a company understands both options, its decision makers will not be in positions to make the best decision for the company.
Weighing the Options
Obtaining a business loan can be a very slow and demanding process for a company. In most cases the financial institution requires a substantial amount of documentation in order to prove they have the ability to repay a loan. This documentation can take the form of business plans and several years of financial records to cash flow projections and scrutinizing of the company’s credit rating. On the other hand, invoice factoring places its focus on the value of the company’s accounts receivables which are the customers to whom your company has sold goods and services on credit.
Making a Choice: Factoring Fees or Interest Rates
On the surface, it might appear invoice factoring is more expensive for a company than bank financing. This misconception is based upon the assumption that the factoring fee which may amount to two percent of the total face value of the company’s accounts receivables amounts to an annual rate of 24 percent. In the real scheme of things, however, a company that factors monthly invoices of $100,000 at two percent will pay a monthly fee of $2,000. When you multiply those fees over the course of a year (12 months), it will cost the company $24,000 in fees they must pay to the factoring company in return for $1,176,000 in immediate cash flow on an annual basis.
Conversely, a one-time bank loan of $100,000 that carries a 12 percent APR and minimum monthly payment of $1,000 will cost the company $12,000 in annual interest alone; the company will still owe the principle of $100,000 for the face value of the loan. Factoring provides an immediate solution to cash flow problems and allows the company to have available cash for payroll or other expenses without forcing it to assume additional debt or long-term obligations.
Benefits of Factoring
The low cost of having immediate cash flow by selling a company’s accounts receivable allows it the freedom of enjoying debt-free cash since these funds are unrestricted; this is in contrast to some traditional lines or credit or bank loans that may carry restrictions on how the company can use the proceeds of the loan. The company can use cash from invoice factoring in any way it sees fit or finds necessary.
The turnaround time for invoice factoring is much shorter than the time frame required for obtaining a business loan. Quite often a company can receive cash in as little as 24 hours once it has an established relationship with a factoring company. This type of financing also creates less stress within the company’s accounting department since it does not require any scrutiny of the company’s financials in order for the company to receive the funds. Invoice factoring allows companies to obtain cash on short flow without the need to go into debt in order to obtain cash it needs for its business-related expenses.