HERE ARE TWO IMPORTANT STRUCTURES TO UNDERSTAND:
FACTORING = PURCHASE OF RECEIVABLES.
AR FINANCING = LOAN SECURED BY RECEIVABLES.
People often use these terms interchangeably, but we're going to separate them.
1. FACTORING — THE RECEIVABLE IS PURCHASED
How Traditional Factoring Works
With traditional factoring, a business sells eligible accounts receivable to a factoring company, known as the factor.
Here's a simple example:
A business completes the work and issues its customer a:
$100,000 invoice
The customer's payment terms are:
Net 60
That means the business could be waiting approximately 60 days to receive its money.
But the business may need that cash today to meet payroll, purchase materials, take on additional work, or cover other operating expenses.
Rather than waiting 60 days, the business may sell that eligible receivable to a factor.
The factor might advance:
80%–90%+ of the invoice value
So, on a $100,000 invoice, the business could potentially receive:
$80,000–$90,000+ upfront
The exact advance rate, fees, reserve, and structure depend on the factor, the transaction, the industry, and the creditworthiness of the account debtor.
When the customer eventually pays the $100,000 invoice, the payment goes to the factor.
The factor then deducts its factoring fee and any applicable charges, and releases the remaining reserve balance to the business.
The receivable is being sold—not simply borrowed against.
That distinction is important because traditional factoring underwriting often places significant emphasis on the quality of the accounts receivable and the creditworthiness of the customers who owe the money.
The question isn't necessarily: "How perfect is the business owner's credit?"
A more important question can be: "Who owes the money, and how likely are they to pay?"
Consider a small business that has less-than-perfect credit but has legitimately completed $500,000 of work for:
A Fortune 500 company
A government agency
A major hospital system
A large manufacturer
An established national retailer
If those invoices meet the factor's eligibility requirements and the account debtors have a strong payment history, those receivables may represent a significantly different credit risk than the small business's own credit profile might suggest.
That's one of the fundamental ideas behind factoring:
The strength of the receivable can matter as much as—or sometimes more than—the financial profile of the business waiting to be paid.
Factoring isn't about creating revenue that doesn't exist.
It's about turning legitimate, unpaid invoices into working capital sooner.
2. ACCOUNTS RECEIVABLE FINANCING — BORROW AGAINST THE AR
An Accounts Receivable (AR) financing facility can look similar to factoring on the surface, but the underlying structure is different.
Instead of selling individual receivables to a factor, the business typically borrows against eligible accounts receivable.
Think of it as a: Revolving Line of Credit supported by: Accounts Receivable
A company has: $2,000,000 in eligible accounts receivable.
A lender establishes a borrowing base and determines what percentage of those eligible receivables can support the facility.
For example, if the borrowing base allows the company to borrow against 80% of eligible AR, the potential borrowing availability could be: $2,000,000 × 80% = $1,600,000
The company doesn't necessarily receive $1.6 million automatically.
Instead, that amount represents potential borrowing availability, subject to the facility's terms and any other borrowing-base requirements.
As the company generates additional eligible invoices: Borrowing availability may increase.
As customers pay existing invoices: The outstanding balance is paid down, and the borrowing base adjusts.
New eligible invoices can then: Replenish borrowing availability.
This creates a revolving working-capital cycle that can grow and contract with the company's receivables.
The easiest way to understand the distinction is:
FACTORING = Purchase of eligible receivables
versus
AR FINANCING = Loan or revolving credit facility secured by eligible receivables
They may both provide working capital based on a company's receivables, but they are different financial structures.
That can mean differences in:
Underwriting
Documentation
Collateral requirements
Fees and interest
Borrowing mechanics
Repayment structure
Customer notification and collection procedures
Ongoing reporting requirements
And, importantly, they may serve different types of borrowers and different business situations.
The key takeaway for a business owner is simple:
Factoring converts receivables into cash by selling them.
AR financing uses receivables to support access to borrowed capital.
Same underlying asset. Different financing structure.
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Educational information only. Olsen Business & Financial Solutions Consultants (DBA - BizMoolah) does not provide legal advice. Financing, restructuring, consolidation, and other solutions are subject to qualification, availability, creditor approval, contractual terms, and applicable law.