Factoring, Asset Based Lending and Bank Financing

Just what is the difference between bank financing, factoring and asset-based lending?

Factoring by definition is: the business of purchasing and collecting accounts receivable or of advancing cash on the basis of accounts receivable.

Factoring is a purchase agreement and differs from other types of financing.

Bank Financing

Banks analyze the financial condition of the borrowing entity and perform a "debt service analysis" to determine the ability of the company to repay its loan through cash flow. Additionally, banks look at the other obligations (debt) the borrower has and typically look for secondary collateral (personal guarantee, home equity of the guarantor(s), company-owned real estate, etc.) as further security for its loan. The borrower's business and personal tax returns are also analyzed to determine a "global cash flow" or revenue from all sources net of all debt obligations. Lastly, the borrower's personal credit score is taken into consideration.

As a general rule, credit scores under 650 need an explanation (typically in writing to be placed in the credit file). Banks have regulated guidelines as to what is acceptable and limit exceptions as loans have to be justified to the bank's credit committee, owners, and industry regulators. However, bank financing is less expensive if the company qualifies.

Factoring

Factoring is more concerned with the quality of the accounts receivable and the financial strength of the client's customers. Often times, high growth companies outgrow their bank line of credit and need more financing to continue to expand. As a factoring client, your line of credit grows as your accounts receivable grow allowing you the freedom of having the capital to expand your business and profits.

While factoring is more costly, it is much more flexible. Often times, a large portion of the factoring expense can be offset by taking discounts (where offered) from suppliers for early payment (i.e. 2% 10, net 30).

Further savings can be had by decreasing the amount of time accounts remain on the aging report - known as "days sales outstanding."

As an additional service some factoring companies offer credit management, credit protection, accounts receivable bookkeeping, and collection services to accompany the purchase agreement. This service effectively outsources your back office credit functions and turns these expenses from fixed to variable.

The factoring transaction involves the purchase of the invoice itself. The factor buys account receivables at a discount through a cash advance. All or a portion of the reserve is released upon payment of the invoice by the client's customer. Instead of earning interest the factor earns a discount or factoring fee.

A cost analysis of your current credit function and the factoring costs would need to be conducted to confirm if this service is right for your business.

Asset Based Lending

The asset-based loan is just that –a loan. The company borrows money incurring loan fees and interest charges.
The loan is collateralized or backed by assets of the business. This can include the account receivables but can also extend to other assets including inventory, raw materials, equipment, patents, or fixed assets.

All in the Family

When an asset based loan is secured just by the accounts receivable the distinction between the two can become blurred. Both the lender and the factor usually verify invoices and use some sort of lock-box system to accept payment on the invoices.

The costs can vary greatly so neither factoring or asset-based lending can be deemed the most or least expensive. It is safe to say that specialty financing is generally more expensive than traditional bank financing.

It is best to shop around and compare the costs and benefits of both options.

Factoring and asset based lending can both be categorized as types of asset based financing, with the big difference being an asset loan versus an asset purchase at a discount.

At the end of the day, both can be viable options if it fills the company's appetite for working capital at a cost that still enables growth and profit.

All three sources of financing provide a service to small business. Your business cycle and characteristics of your industry will determine the right place for your company's financing needs. Huntington Coast Capital can assess the best options for you and put you in touch with the appropriate finance partner.