For example, if an invoice is generated by the business at net 30 days for $1000.00 and the factoring company purchases it at a 2% discount factoring rate. The business would receive $980.00. The factoring agreement would spell out the terms of the sale for ongoing purchases and the factoring rates.
The factoring agreement is a buyer/seller agreement whereas the business has agreed to sell invoices for specific customers and the factor has agreed to purchase at a certain discount rate.
A bank that offers an accounts receivable line of credit is not a purchase, but rather a revolving line of credit based on the receivables the business has. The bank would determine the advance rate based on the ongoing receivables the business generates. Some receivables from certain industries do not qualify. For example, the oil field industry is always on and off the approval list depending on the oil prices and economic atmosphere. Banks always have a cap on concentrated receivables usually capping at 30% which can be a very vital mistake for the business owner. Factoring companies can advance up to 98%.
It is much easier to get approved by a factoring company because the majority of the decision is based on the credit quality of the buyers. An invoice factoring agreement can be approved in a matter of 2 or 3 days. The credit limits assigned are based on each buyer, and can easily be moved up with the same day.
A bank has to review all the financials of the business before it approves the loan on the receivables and most likely decline. The bank’s final outcome is they offer a low advance rate on the receivables because they are not familiar with the account buyers and are basing on industry and previous transaction history. Banks also have many covenants on the loan agreement that caps the business more often than not. The time frame is very long for approvals that usually take months for the decision.