Which Financing Option is Best for Your Business?
Most businesses will require financing at some stage in their development. For example, there might be a need for additional working capital to fund expansion. Or funding may be needed to ease ongoing cash flow timing issues. Fortunately, there are various options open to businesses looking for finance, including invoice factoring and lines of credit.
Sales invoice factoring and lines of credit both offer a flexible way to finance a business. However, both have advantages and disadvantages. So, how do you decide which will be best for your business?
What is Invoice Factoring?
Invoice factoring is a means of obtaining advances against unpaid sales invoices. Also known as accounts receivable (AR) financing, invoice factoring is available to most businesses that raise sales invoices. It is relatively straightforward to gain approval for factoring, even for companies with less than perfect credit ratings.
Once the business is set up, obtaining advances against invoices is simple. You submit copy invoices to the factoring company for verification. Once the invoices are approved, the factoring company will advance up to 90% of the invoice value. The customer then pays the factor rather than the issuing company. When the customer settles the invoice, the factoring provider will remit the balance of the invoice, less their fees.
Related: Is Invoice Factoring Right for Your Business?
What Is a Line of Credit?
A business line of credit is a revolving credit line that operates similarly to a credit card. A bank or other financial institution approves a credit limit against which the company can borrow, as and when needed. Interest is charged on the amount borrowed until the balance is repaid.
The approval process and requirements for a line of credit are similar to that of a bank loan. Lines of credit for relatively small amounts are generally unsecured. However, collateral will probably be required for a significant sum. Lines of credit also usually come with certain other contractual obligations. For example, a line of credit contract might stipulate financial ratios of the business that must stay within specified levels.
Invoice Factoring and Business Lines of Credit Compared
The operation of the two financing methods is, quite clearly, different. However, both offer flexible financing. Still, there are some other critical differences between factoring and lines of credit of which you need to be aware.
Qualification
The qualification requirements for a line of credit are stringent. Typically, a company will need to have been in existence for at least one year, have a good credit track record, and collateral may be required. The requirements for factoring, on the other hand, are less demanding. Start-ups will be considered, the sales invoices provide security, and customers’ credit rating is more important than the applicant company’s rating.
Credit Limits
Both options have credit limits, but factoring limits are the most flexible. Factoring financing varies with the value of sales invoices. If the monthly value of invoices significantly increases, obtaining approval for a credit limit increase is generally straightforward. However, if you max out a bank line of credit, applying for an extension will not be as simple. Increasing a line of credit would require re-approval and a good track record of maintaining the existing facility.
Accessibility of Funds
Once a line of credit is approved, the funds are available to the business, regardless of sales volume. Factoring advances depend entirely on the value of sales invoices raised. Consequently, if a company were to experience a period of low sales, factoring advances would decrease. However, a company with a line of credit would have access to those funds, even if sales are lower than anticipated. It should be borne in mind, though, that persistent low sales could breach the terms of a line of the credit agreement and result in a reduction or removal of the facility.
Collateral
When you factor sales invoices, you assign the invoices to the factor which provides collateral for the advance. Consequently, there is usually no need for further collateral or personal guarantees. However, a business line of credit will likely be secured against company assets, and a personal guarantee may also be required.
Related: How Will Invoice Factoring Affect Your Customers?
Facility Maintenance
Maintaining a factoring agreement is relatively straightforward. So long as you follow the procedures and do not experience excessive bad debts, the facility will roll over from one year to the next. Credit lines, on the other hand, are usually periodically reviewed. To maintain a credit line, the facility must have been well-managed. The conditions and covenants of the agreement will also need to have been met.
Time Frame for Approval
It generally takes around two to three weeks to gain approval for and set up a factoring arrangement. A line of business credit application will probably take about two to three months to process.
Impact on Credit Rating
Sales invoice factoring is off-balance-sheet financing. The advances do not show as a liability on the balance sheet, so factoring will not affect a company’s credit rating. However, the increased availability of cash would enable faster settlement of debts, possibly improving the credit rating. On the other hand, a credit line is a liability on the balance sheet, so it will likely affect the ability of a company to obtain further credit. Still, proper long-term management of a credit line facility could improve a company’s credit rating.
Cost
The cost of both options can vary considerably. On average, Fed policymakers said they expect interest rates to climb to around 3.4% by the end of this year, up from 1.9% they were projecting in March likely increasing the cost of a line of credit. One of the potential drawbacks with factoring is that you do not control how long the advance is outstanding; your customer does. Interest accrues on sales invoice advance until the customer settles it or the advance is repaid.
Related: How to Calculate if Invoice Factoring Will be Cost-Effective for Your Business
Which Financing Option is Best?
There is no right or wrong answer as to which is the best out of invoice factoring and business credit lines. Invoice factoring is the easiest to gain approval for and maintain. However, factoring will may be more expensive than a credit line, but with today’s increasing interest rates that may not be so. A business line of credit might be the better option for a well-established, stable company. Whereas factoring would provide funding for expanding business, requires no collateral, and is relatively quick and easy to obtain.
Your Questions Answered Quickly
Whether your business is thriving and you can’t keep up, or you are waiting on clients to pay, Universal Funding can help your growing company. Call us at 800.405.6035 or complete our rate form today to learn more about invoice factoring and how it can improve your company’s cash flow.
About Universal Funding
Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.
