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Basic Difference Between Accounts Receivable Financing vs Invoice Factoring

By Annapoorna

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Updated on: Dec 22nd, 2022

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4 min read

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Money is like blood for a business. The business can run smoothly if the flow of funds is uninterrupted. But it can be quite a headache for businesses that allow long periods of credit to customers. With piled-up outstanding invoices and receivables, such businesses constantly face a crunch in their working capital. 

Although businesses can take working capital loans or revolving credit to finance their short-term needs, accounts receivable financing and invoice factoring are preferred for financing against your invoices. This article discusses these options in detail and the basic difference between accounts receivable financing and invoice factoring.

What is Accounts Receivable Financing?

Invoice financing or Accounts Receivable Financing is a process where you can offer your outstanding invoices as collateral and borrow money against them. The financier charges interest on the advance amount. In this type of financing, you retain the ownership of your invoices and the responsibility to collect the payment. 

Here is the process of Accounts Receivable Financing:

First, choose the outstanding invoices against which you want to borrow money. Now, approach an accounts receivable financing business and offer your outstanding invoices as collateral to borrow money. The company approves the advance and sends you the money, after charging interest on the advance amount. Usually, the interest charged fluctuates between 1-3% per month and can be repaid in weekly or monthly instalments. 

Default in Repayment

As stated earlier, you retain control over the bills and the responsibility of collecting the payment. But if you default in repaying the advance, the financier has the right to collect the bills provided as collateral directly from the customers for compensating their loss. 

What is Invoice Factoring?

Another popular method of financing your outstanding receivables is “Invoice Factoring”. In this type of financing, the Factoring Company or the “Factor” becomes the owner of your outstanding invoices. Essentially, it buys your receivables and pays a percentage of the same in a lump sum, or in other words, discounts on your outstanding invoices. 

But it keeps a margin which is paid only after the amount is received from customers. So, the responsibility of collecting customer payments remains with the factor. Here is the process of Invoice Factoring.

First, identify the outstanding invoices you want to get financed from the factor. The factor approves your proposal and buys your outstanding invoices by paying a lump sum (a portion of the total bills) value as a percentage of the total bills.

The remaining amount is paid by the factor after the customers make the payment. As compensation for extending advance payment to you, the factor charges discounting and factoring fees. Usually, the charges are anywhere between 1-2% per month. 

Difference Between Accounts Receivable Financing vs Invoice Factoring

Now that you have understood the basics of accounts receivable financing and invoice factoring, it is important to understand their key differences. Here are the differences between accounts receivable financing vs invoice factoring.

Basis of DifferenceAccounts Receivable FinancingInvoice Factoring
Type of financeSimilar to a business loanLump sum payment against bill discounting
Type of transactionAdvance against the collateral of receivablesThe factor buys your outstanding invoices
Ownership of receivablesThe ownership remains with youThe ownership is transferred to the Factor
Collection of duesYou need to collect the duesThe factor collects the receivables
Types of chargesInterest on advanceDiscounting and factoring fees
Recourse optionNo recourse as the transaction is based on the principles of loanYou can choose whether the factor has a recourse option or not. The charges are higher for non-recourse financing
Default on repaymentIf you default, the financer can collect the payment from collateral bills as compensationRecourse: The factor recovers the loss from you
Non-Recourse: The factor bears the loss of default

Conclusion

You must have understood the basics of, and differences between, accounts receivable financing and invoice factoring. These are two of the most popular invoice financing methods that businesses follow to fund their working capital requirements.

About the Author

I preach the words, “Learning never exhausts the mind.” An aspiring CA and a passionate content writer having 4+ years of hands-on experience in deciphering jargon in Indian GST, Income Tax, off late also into the much larger Indian finance ecosystem, I love curating content in various forms to the interest of tax professionals, and enterprises, both big and small. While not writing, you can catch me singing Shāstriya Sangeetha and tuning my violin ;). Read more

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