Factoring Companies vs. Traditional Lenders: Which is Best?
When comparing invoice factoring companies to traditional bank lenders, there truly is no right or wrong approach. The short answer to “which method is best” is that it simply depends upon each company’s financial needs. Our goal with this article is not to steer prospective borrowers in any specific direction, but rather to act as an educational source in order to help each company make an informed decision. However, based on our experience working with many newer companies, we typically find that factoring acts as a great “bridge” option until our clients have enough time in business to qualify for a bank line of credit.
According to a Small Business Trends article written by Shubhomita Bose:
“Big banks approved 23 percent of funding requests in March, up two-tenths of a percent from February 2016.”
While this shows a positive trajectory in the direction of bank loan approvals, it still implies that over 75% of the businesses applying for bank loans are not receiving them. While that 23% is expected to continue to rise this year, there have to be other options for small businesses when they fall among those two-thirds of organizations that are not approved.
Benefits of Accounts Receivable Factoring and Traditional Lines of Credit
Perhaps one of the most often recognized benefits of utilizing a bank line of credit, as opposed to invoice factoring, is that the bank line will be more cost effective. Traditional banks have a much lower cost of funds than most factoring companies, which means they are able to lend their money to borrowers at cheaper rates. Additionally, banks do not provide any of the back office support functions that factoring companies offers, which allows the banks to charge less for their financial services. If your business is in a position where the only need is a line of credit, and a bank is able to approve your business line for the necessary amount, then this may very well be the appropriate financial decision to select. However, if your situation is not so straight forward, a factoring company may be able to provide you with the services necessary to facilitate your growth and success.
While factoring rates are typically a little higher than the rates charged by a bank, factors are also comfortable working with companies that banks are often unable to help. For instance, factoring companies work with start-ups, businesses that have past bankruptcy or tax lien issues, organizations that have seasonal volume fluctuations, and much more. Since the factoring company simply purchases the client’s receivables after the good or service has been provided, they are not concerned with many of the items that a traditional bank considers when evaluating a loan application. Furthermore, a bank approves the client for a pre-determined amount of credit, whereas the factoring company can purchase as many receivables as the client is able to generate. Since the factor pays their client within 24 hours of receiving a copy of the invoice, the business does not face cash flow concerns. There is no line limit imposed upon the company as there is by the bank.
A second, yet equally important function of accounts receivable factoring companies is to provide clients with back office collections and invoicing support. Many businesses will rely on their factor to issue invoices to customers on their behalf. However, all invoice factoring clients will receive the collections assistance offered by their funding partner. These tasks can help eliminate the need for businesses to hire additional employees, or re-assign existing staff, which will ultimately contribute to the client’s bottom line. Additionally, the factoring company will provide free credit checks for any new customers that the client is interested in working with. The factoring client will know whether or not their prospective customer pays their bills, and what type of pay terms can realistically be expected. While these services are provided at no charge by the factor, they’re unfortunately not an option that banks are able to offer their clients.
Issues to Consider when Comparing Factoring Companies and Bank Loans
One noteworthy item that should be considered is how well your funding partner understands your business and its operations. For example, many banks are uncomfortable lending to transportation (trucking) companies due to several variables. In the end, banks largely just do not understand this industry and, therefore, are uncomfortable providing sufficient lines of credit for many small and medium-sized trucking companies. On the other hand, the transportation sector is arguably one of the largest niches within the factoring world. Transportation factoring, also known as freight bill factoring, is typically handled by companies that specialize in this area and know the industry inside and out. In fact, all invoice factoring providers seem to take a more hands on approach to understanding the industries and companies they serve. This allows for a much stronger relationship with the client and helps to set each client up for success.
Some other common items to consider are the differences between approval processes among receivables factoring providers and traditional banks. If a business has the time to wait for a bank to evaluate their credit application, then there is certainly nothing wrong with doing so. However, if time is of the essence, factors can typically have a new client account up and funding within 5 business days or less. Banks generally take at least two weeks for approval, but that time frame is often closer to three or four weeks in most cases. Additionally, small business factoring companies are accustomed to accepting a very limited amount of paperwork from their clients in order to approve the account. If prospective clients have “blemishes” on their credit or business history, factors are also able to work around these on many occasions (depending on the circumstances) in order to help the client secure a working capital facility.
Other Services Provided by Banks and Factoring Companies
Banks are able to provide certain perks where factors are simply not able to compete. Some of these examples include business bank account features, payroll services, and equipment financing. However, it should be noted that more and more funding sources are offering equipment financing services as well. Generally, when a factor provides equipment financing, there is not an additional application process. Approval is typically based upon specific aspects of the client’s relationship with the factoring company. In addition to equipment financing, many funding companies are also comfortable providing short term loans to their clients along with purchase order financing for manufacturing businesses and supplier financing for construction companies.
Summing it Up
As stated earlier, a traditional bank line of credit may very well be the right choice for your businesses. If you have been operating long enough to qualify for bank financing, and urgency of funding is not an issue, a bank line will almost always be cheaper than a factoring line. However, if you are a newer company, or cannot qualify for a bank loan for any reason, there is a very good chance invoice factoring may be the right solution for you.
To learn more about whether our invoice factoring services may be the right fit for your business, contact us today or feel free to browse our website to learn more. Our Invoice Factoring Companies Guide is also another educational source. Regardless, our goal is simply to help you make the best financial choice based upon your business’s circumstances (whether or not that entails factoring). We look forward to being of service!