Although it is true that when your business factors your invoices, it does take the collections process out of your hands, factoring is not debt collecting. By understanding the difference between the two, your business can have the knowledge to use accounts receivable financing to push your business forward.
Definitions of Collections and Factoring
In debt collections, a third party agency will attempt to collect money from your customers who have not paid their account. Generally, your business will have already attempted to collect the money which is owed to you, but been unable to do so. This third party may use phone calls, letters, and even legal means to retrieve the debt.
In factoring, your business sells the credit-worthy accounts to a third-party lender. This lender, or factor, provides you with a percentage of the invoice until it is paid. At that point, the factor takes the money which it provided to your business and its fees, then returns the extra to your business. The invoice is collected, but much as it would be if your business waited for the invoice to be paid.
Key Differences Between Collections and Factoring
When working with a factor, your business has a different purpose in mind. You are receiving working capital to advance your goals. With collections, you may not actually ever see any money out of it. You are attempting to collect what is owed. It’s not guaranteed income. The factor does collect the invoice, but it is treated as is the customer fully intends to pay to preserve your relationship with your customer.
Accounts receivable financing is based on current invoices, while collections are based on old invoices. Factors generally charge between three to seven percent of the invoice, while collection agencies might charge 25 percent or more. The risk is much different. A factor has checked out the credit-worthiness of the customer and believes that they will make good on the invoice. With collections, the customer has already shown that they are not worthy of being granted credit.
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With factoring, the funding is guaranteed. With debt collections, it’s a gamble. In order to find out if accounts receivable financing is a good option for your business, you should speak to a factor who understands the marketplace and can help you completely see how it would work in your business. A factor can be a great partner to work with your business and help you grow when you need working capital.
