Comparing Invoice Factoring to Asset Based Lending

A loan from your bank may be a funding solution for well-established companies with consistent revenue streams but what about companies that operate cyclically? Or companies that need quick access to inventory or raw materials and can’t afford to wait 60 – 90 days for payment? Or startup businesses that simply don’t possess the detailed financial history to get approved for a loan?

There are other options better suited to the unique needs of these companies. AR financing, namely invoice factoring and asset based lending, specifically address the needs of each of the previously mentioned hypothetical clients. The following blog addresses the differences between both and the types of customers that could take advantage of them!

What is invoice factoring?

Invoice factoring provides cash flow and working capital to a customer when a company sells its unpaid invoices (the receivables) to a factoring company. In return, the factoring company provides the client with immediate cash, which is typically an agreed-upon percentage of the invoice amount. Once the invoice is paid, the remaining balance - minus a fee - is paid to the client.

Invoice factoring gets a company paid faster than waiting for their customers to pay invoices. In fact, once a factoring line is set up, invoices can often be financed within 24 hours of the invoice being issued. This speeds up cash flow and provides working capital for the company to pay operating expenses and grow without adding debt and increasing leverage.

What is an asset based loan?

An asset based loan (ABL) is a revolving line of credit based on the value of the assets you've pledged as collateral for the loan. Collateral can include accounts receivable (AR), inventory, equipment, and, in some cases, real estate. The acceptable asset mix depends on the lender and the type of collateral they are willing to loan against. For Commercial Funding Inc.’s ABL loans, AR must be the primary collateral that it lends against with a smaller amount available towards inventory, equipment, or real estate.

What are the differences between invoice factoring and ABL?

With invoice factoring, the company sells its AR to the factoring company. ABLs are structured as loans or lines of credit, allowing businesses to draw funds up to a certain limit based on the value of the collateral, not to exceed the total limit of the credit line.

Invoice Factoring

With invoice factoring, the amount of funds available depends on the outstanding accounts receivable. With ABL the amount of funds available depends on the total amount of all the eligible collateral, potentially resulting in larger lines of credit. That being said, the underwriting process and documentation needed to fund an ABL transaction will be more stringent than factoring.

Invoice Factoring is a financial solution best suited for businesses and industries that need consistent, stable cash flow to operate effectively, but also suffer from long payment cycles (invoices that take more than 30 days to get paid). Here are a few examples of industries that typically benefit greatly from invoice factoring:

1. Transportation

   1. Costs associated with maintenance, fuel, and payroll require immediate attention, but payments may lag 30 days or more. Factoring can alleviate the stress of waiting for payments on a schedule that can be hard to predict, thus smoothing out cash flow. This can be especially beneficial during peak seasons.

2. Staffing

   1. Staffing firms must pay their employees weekly or bi-weekly while the clients they serve may take months to pay their invoices. Invoice factoring bridges the gap between payroll obligations and payments received.

3. Oil & Gas

   1. Another example of an industry filled with businesses that can become quickly afflicted with the high overhead costs of drilling equipment, maintenance, transportation, etc. especially when burdened with long payment schedules.

Other industries that are a good fit for invoice factoring include manufacturing, wholesalers, and other business-to-business companies.

Asset-Based Lending

ABL similarly benefits industries that are hindered by long payment schedules but, in contrast, have a larger base of assets. Here are a few examples of industries that stand to benefit greatly:

1. Manufacturing

   1. Manufacturing companies typically have significant investment tied up in equipment, inventory, and accounts receivable. The flexibility of an asset-based loan could provide the necessary working capital when opportunities such as new contracts present themselves.

2. Wholesale & Distribution

   1. Distribution centers house massive amounts of inventory and frequently have large amounts of AR due from their retail customers. Asset based loans could provide a strategic advantage for those wholesalers that are hoping to restock inventory, cover operating expenses, or otherwise expand their businesses.

Many of the same industries that factor their invoices can also take advantage of ABL.

For companies that don’t initially qualify for an ABL facility, they can begin with a factoring line and grow into an ABL. Even if a company doesn’t have inventory, equipment, or real estate, it can still get an asset-based loan based on its AR when it meets underwriting requirements.

For questions regarding invoice factoring, asset-based lending, or the qualifications required for both, please contact us.