Receivables Factoring
A Borrower’s Management Team Assigns or Sells the Account Receivable at A Discount to Its Face Value. The Cash Amount Is Expressed in Percentage Terms and Is Referred to As The “Advance Rate.” An Advance Rate Can Be Thought of As A “Loan-To-Value” And It’s Derived in A Similar Way to How A “Borrowing Base” Or A “Margin Rate” Might Be Calculated on An Operating Line of Credit By A More Traditional Commercial Lender.
Accounts Receivable Factoring Vs. Traditional Operating Line of Credit.
Both Accounts Receivable Factoring and Operating Lines Are Considered Forms of Post-Receivable Financing, Meaning an Invoice Has Been Generated (As Opposed to Purchase Order Financing, Which Is Pre-Receivable). Assuming A Commercial Borrower Qualifies for Both, Why Might Management Choose One Over the Other?
There Are Advantages and Disadvantages to Both, Best Illustrated When Measured Against the Following Dimensions:
Interest Rate.
Rates Can Vary Considerably Based on A Borrower’s Risk, But in General, An Operating Line of Credit Will Cost Between 1% And 3.5% Over the Lender’s “Base Rate” (Like Bank Prime), Meaning an All-In Annual Interest Rate Of ~4% To ~9% Depending on The Jurisdiction and The Rate Environment. Factoring, On the Other Hand, Will Often Cost 1.5%-3% Per Month (For an Annualized Rate Of 20%-45%).
Duration of The Exposure.
While Subject to Annual Reviews and Margining Requirements, A Bank Operating Line Is Usually Extended to Revolve on An Ongoing Basis, As Long as The Lender Can Remain Comfortable with The Borrower’s Risk Profile. Accounts Receivable Factoring Exposure Generally Only Lasts as Long as The Vendor’s Payment Terms with Its Buyer (Usually 30-90 Days).
Loan-To-Value (LTV)
A Bank Line of Credit Will Generally Advance Up To 75% Of Good Accounts Receivable (Meaning Under Some Aging Limit–Usually 60 Or 90 Days). Many Factoring Companies Will Offer an Advance Rate Of 75-90% Of an Invoice’s Face Value. This Higher Advance Rate Is Considered Attractive by Many Borrowers and Might Justify the Higher Cost.
Purpose of Loan Proceeds.
A Bank’s Line of Credit Is Used For “General Working Capital” Support. This Means It Bridges A Borrower’s Working Capital Funding Gap; It Would Usually Be Frowned Upon (Or Even Restricted) To Use the Proceeds to Fund A Dividend.
Factoring, On the Other Hand, Often Has Very Few Restrictions on The Uses of Loan Proceeds. This Flexibility Is Another Reason Many Borrowers Might Be Willing to Pay A Premium.
Frequently Asked Questions
Get the Answers you Need to Common Questions About Receivables Factoring. Everything you need to know about Receivables Factoring and How your Business can Qualify.