If you own a business, you are probably familiar with that uncomfortable feeling of needing cash quickly. While bank loans and investors are great for large amounts of funding, sometimes you need the cash in the next few days and you can’t wait months for approval. During crunch time, many enterprises turn to factoring receivables or product order financing.
The Big Difference
Businesses that allow customers to pay for products and services over time have accounts receivable. Simply put, these are the outstanding accounts that have yet to be paid in full. During the factoring process, your business would sell the accounts receivable to a third party for a fee. The fee is usually around ten percent of the accounts’ total worth and everything left is given to your company in cash. Product order financing is funding given to your enterprise so that it can manufacture and fulfill an order that has already been placed.
Restrictions and Limitations
The accounts receivable option is virtually limitless. If you have the outstanding accounts, your third party institution will gladly take them off your hands and you can use the money anywhere in the business. Conversely, product order financing may not be given if you don’t have a profit margin of at least 20 percent. Furthermore, there is not the opportunity to expand the loan since it is based on a set order. Additionally, the funds can only be used to fulfill the product order.
Third party factor institutions do not care about a company’s product margins, but they do care about the customers’ credit worthiness. Essentially, these companies are now dependent on your customers’ ability to pay the bill. Because product order financing does not depend on accounts receivable, this information is irrelevant to the process. For both methods of funding, your business does not necessarily need a good credit history or any credit score at all.
Account receivable financing is fairly cheap in comparison to PO financing. The risk to the lender is considerably lower so interest rates remain small in the 1-4 percent range. On the other hand, PO financing has interest rates in the 5-10 percent range. In this case, the lender runs the risk your product not selling or your company failing to produce. There may also be other fee and penalties depending on the terms of the loan.
These short-term options get your company cash fast when you are in need. Each option has its own pros and cons, so be sure to carefully consider both before committing. Pick what is best for your business.