Without focusing on the costs involved with these different forms of commercial financing, I would like to highlight the reasons and benefits a business might choose one or the other. This post will assure you that each type of funding has their legitimate specific reasons for picking one over the other.
The foundation of the difference is; one is a term loan and the other is a working capital line.
When a business is faced with a capital expenditure and knows it will have trouble coming up with the full payment on buying a piece of equipment, or paying for a marketing campaign for instance, the best solution to this problem is to stretch out the cash outlay over a period of time. This is the definition of a term loan; you apply – get a check – start using the funds – and make monthly payments over time. This can be incredibly helpful and can easily be fitted into an annual operational budget. But it’s one check and many payments. Great for buying large ticket items.
But a business in a growth spurt, getting new contract awards, hiring new employees, increasing their weekly payroll, worrying about monthly 941 obligations, well one check in May won’t cut it. This business needs ongoing access to working capital. It needs to draw as it grows and not be hindered by its own financial balance sheet. By factoring invoices, a company has direct access to capital on a continuing basis for as long as they need it. This could be weekly or monthly, whenever there is an invoice for finished work. And the funding does not result in loan payments.
So I always say – “use the right tool for the job.” Don’t pick up saw to tighten a leaky pipe, use a wrench. Understand what you need to accomplish and find the correct solution for your situation.