The difference between the fees associated with accounts receivable factoring and the Annual Percentage Rate (APR) commonly used when borrowing capital is the same as having a dog on a short leash or a long one. The long leash comes with a history of paying attention and maturity while a short leash means quick oversight and keeping out of trouble.
In other words it’s directly related to the small business being able to qualify for a bank loan. Either the financial condition of the company will allow securing a conventional loan or you have to seek funding elsewhere. A bank loan means significant assets available as collateral, profitability and sound management.
For our clients, a bank loan is the ultimate goal, but getting there requires outside capital. Strictly speaking, using accounts to fund using factoring is not a loan at all. The factor is purchasing the underlying value of the obligation from a creditworthy customer to pay an invoice. This is why the decision to fund is based on that customer’s credit.
A factoring transaction is much more than paying a monthly loan payment after qualifying for a loan. The short leash entails various staff activities that allow the factor to know within 30 days whether there is a problem with the account. Therefore, a factoring company does not lend money to a company for a year, it buys accounts receivable that in exchange requires a service charge based on the transaction.
The proper way for a small business to calculate the value of factoring is to first consider their profit margin on a sale. If deciding whether the company can afford to make the sale based on payment terms with the customer – will the factoring service charge allow the company to move forward faster by giving up a few points of profit? It’s not APR as a cost, but instead total annual profit increased by turning internal capital faster and more efficiently.