Finance for a Business: Line of Credit vs. Factoring

Quite a few people think that when someone needs finance for a business, he should get a bank loan. The business owner gets a lump sum of money, and then after a specified period of time they repay the amount with interest. But today, there are already quite a few options for business to business finance.

A business, for example, may have a line of credit available for them. Or perhaps they can also enter a factoring deal with asset based lending companies. So which one is better for a small business?

What is a Line of Credit?

When a business has a line of credit, then the owner may take out an amount of money depending on how much they need at any given moment. The line of credit has a maximum amount, and they can’t borrow money more than the limit. When they repay the money they borrow, they then increase their credit line.

Using a credit card is very much like a using a line of credit. If you have a maximum limit of $10,000 on a credit card, then you can only borrow up to that amount before you start paying off what you owe. Meanwhile, you also have to pay interest.

What is Factoring?

Factoring is a type of financing without technically getting a loan. Instead, you give your accounts receivable to a factoring company, and in return you get an advance on the value of the money instead of waiting for it. So if an invoice is worth $10,000 and the factor agrees to advance 80%, you get your $8,000 right away instead of waiting for 30 or 60 days. When your customer pays up in full at last, the remainder of the money is passed on to you, once the factor has taken off its fees.

Which Is Better?

If you can get a line of credit, it may seem like this is the better option. But the operative word here is “if”. Getting a line of credit from a lender or a bank is not as easy compared to dealing with a factoring company.

First of all, the factoring company doesn’t really care about your credit rating. They mostly care only about the credit rating of your customers. If your customers have stellar credit, then factoring approval is almost automatic.

Using a credit card or a line of credit may also pose risks for your company, because you can’t really be sure that you’ll be able to pay back the loan with the interest on time. That’s not really so much of a risk with factoring, because you’ve already made the sale with your customer. You already have the money to pay the advance, except that you need to wait until the due date of the invoice.

When it comes to finance for a business, you may find that factoring offers the least amount of risk for your business. When you have excellent customers, you have little risk of getting your application for financing rejected, and you have little risk that your factor won’t get back the money they advanced to you.