The comparison comes up whenever a business needs working capital. On the surface both options put money in your account before your customers pay. Underneath, they work in opposite directions: one is a sale, the other is borrowing.
What is being reviewed
A bank assesses your business. It looks at financial statements, trading history, existing debt, the security available and how the loan will be repaid. The decision is about your business as a whole, which is why a newer company with a short record can find it hard to qualify, and why an established one can borrow against its overall position.
A factoring provider assesses the invoices. It looks at which customers owe the money, whether the work was completed and accepted, and whether the invoice is likely to be paid on its due date. Your business still has to be sound, but the credit decision is largely about the people you invoice.
Balance sheet effect
Money borrowed on a loan appears as a liability and is repaid over the term, with interest. A factored invoice is sold, so it leaves receivables rather than appearing as debt. What remains on the statement is the cost of the arrangement, being the provider's fee.
This difference matters beyond accounting. It changes how the business looks to another lender, and it changes what happens if trade slows, because a sale does not leave a balance to service.
Who collects
With a loan, collection stays entirely with you. The bank is repaid on its own schedule whether or not your customers have paid. With factoring, the provider is usually the one collecting, at least under a notification arrangement, and its return depends on your customer paying.
That alignment is one of the practical differences. A factored invoice puts the collection work in someone else's hands, and their incentive is to see it paid.
Flexibility
A loan or line of credit is agreed at a fixed amount. Drawing more requires a new approval, and the facility does not grow automatically because you won a large contract. Factoring capacity tends to move with your sales, since each invoice is assessed as it is submitted, within whatever limits the provider has set.
The commitment runs the other way in some cases. A whole-ledger arrangement can tie you to a provider for a term, whereas a line of credit can sit unused. Flexibility is not automatically on one side.
Cost, in general terms
A loan is priced as interest over a term. A factoring fee is set by the provider and charged against the invoices sold, and it can be expressed as a discount on the invoice or as a charge based on days outstanding. The two are not directly comparable line by line, and there is no single national rate for either.
The useful comparison is the total cost over the same period for the same work. If factoring costs more than the interest you would pay, the question becomes whether the speed and the collections work are worth the difference. If a bank will not lend to you at all, the comparison is different again.
Where each tends to fit
- A loan suits a business with stable trading history, assets to secure and a defined need.
- Factoring suits a business whose constraint is the gap between invoicing and payment.
- A loan is simpler to administer and does not involve your customers.
- Factoring can move with sales and does not require a repayment schedule.
Questions worth asking yourself
- Is my problem timing, or is it a shortage of capital overall?
- Would my customers notice, and would that matter to them?
- Can I support a fixed repayment schedule, or is my cash flow uneven?
- Have I compared the total cost of each over twelve months, not per month?
- What does my accountant say about how each would appear in my statements?
Related types
Whichever route you take, the risk terms in a factoring agreement still need reading. See recourse and non-recourse factoring for that question, and how invoice factoring works for the mechanics, including security registration.