Comparing Accounts Receivable Finance to Factoring

comparing ar finance to factoring

By PrimeRevenue • Published June 22, 2020 • 5 minute read

Volatility in the current business climate has finance executives performing stress tests on cash forecasting. What happens if 20 or 30 percent of a company’s receivables aren’t getting paid? Even prior to the global health crisis, 78 percent of accounts payable departments admitted to paying invoices late. As economic uncertainty drags into 2021, many companies face a cash flow crunch.

New demand for liquidity is driving greater curiosity around accounts receivable finance. Accounts receivable finance unlocks working capital by allowing companies to sell their customer invoices to banks and other funding sources for faster payment. In turn, companies improve cash flow and minimize the need to turn to more expensive sources of liquidity.

One of the most common types of accounts receivable finance is factoring. With traditional factoring, a business sells its accounts receivable to a third-party, usually a bank. While the business is given immediate access to liquidity, it receives far less access to the full amount of the receivable sold than other forms of receivables monetization. For example, a company will receive early payment for 85 percent of the customer invoice amount (minus various fees) from the funder – then the remaining 15 percent will be paid once the customer has paid the funder.

There are additional downsides to traditional factoring. Not only are the fees charged by the factoring company expensive compared to other financing options, the factoring company is also significantly involved in the commercial relationship. Credit lines are typically smaller, resulting in a higher cost of funding for less liquidity. While companies can select which customers they would like to bring into the factoring program, generally all invoices for that customer must be sold. These drawbacks, coupled with the fact that a portion of the purchase price is deferred and paid at the time of invoice maturity, means traditional factoring transactions have a greater risk of being recorded on the company’s balance sheet as debt. If this happens, it can negatively impact the business’s debt-to-equity ratio and credit rating, which can then jeopardize the quality and cost of its broader funding mix.

Is there a better form of accounts receivable finance?

The downsides point to an important question – is traditional factoring worth it? Given its limitations, is it capable of solving the scale and scope of current liquidity requirements? In the current economic climate, the answer may be “no.”

Selective receivables finance is an alternative form of factoring that offers all the benefits of traditional factoring with more competitive pricing and flexibility – without heavy involvement (if any at all) from the factor. It allows companies to sell their accounts receivable with their largest, most creditworthy customers for immediate payment. Even further, the company can pick and choose which individual receivables to sell and secure funding for the invoice amount minus nominal financing fees. Not only does this provide more flexibility, but it also facilitates a more strategic, targeted approach which delivers more value. Financing rates are often much more competitive than other options as they’re based on both the company’s financial performance as well as the customer’s (the obligor’s) credit rating. Because it is considered a true sale of receivables, these transactions do not count as debt on the balance sheet.

There are numerous benefits of selective receivables finance over factoring (and other forms of accounts receivable finance). We dive into greater detail in this white paper for anyone that wants to learn more about accounts receivable finance, but here are some key advantages to consider:

  • Greater flexibility and control, competitive cost. Unlike other forms of accounts receivable finance, selective receivables finance allows you to choose which receivables to submit for early payment based on your unique business needs. It typically targets your largest customers so you can receive more liquidity, faster. Because it takes the customer’s credit rating into consideration, interest rates and financing fees are generally much more competitive than other solutions.
  • Mid-market friendly. Selective receivables finance is a great alternative for mid-market companies who may not have the leverage or credit rating to secure other financing options like commercial or asset-based lending.
  • It doesn’t count as debt. With the proper accounting treatment, selective receivables finance transactions do not count as debt on the balance sheet.

As industries grapple with unprecedented volatility, PrimeRevenue is seeing a strong uptick in demand for selective receivables finance – particularly among companies with a strong need to accelerate cash flow, but few options that aren’t extremely expensive or debt. Today, our selective receivables finance solution processes more than $60B in accounts receivable annually across 100 sellers with more than 400 obligors. Compared to other accounts receivable finance options, selective receivables finance delivers the biggest gains in cash flow efficiency at a competitive cost and lower risk. That’s critical right now as companies broaden their liquidity options and strengthen their ability to weather volatility.