Increasing Cash Flow: Understand the Key Differences between Factoring and a Bank Loan

Posted by Factor Funding Co. on August 18, 2014

With the economy still recovering from the recent downturn, banks are less than eager to extend loans to small business owners. When they need to get cash to grow their businesses, entrepreneurs may wonder what their best option is for quick financing. Many business owners utilize factoring for this purpose and avoid some of the greater complications that come with applying for a bank loan. People can get the financing they need and make the best financial decisions for their businesses by knowing how factoring differs from traditional business bank loans.

 

Credit Check

Most business owners are aware that banks will put applicants through strenuous credit checks. They must have good or excellent credit in most cases to be approved for the money that they need. Owners who have credit challenges or perhaps are recovering from a difficult financial circumstance could be turned down and told that they do not meet the stringent credit requirements imposed by banks. However, factoring does not check the credit of the borrower, but rather that of the invoice customer. If that customer has a solid payment history and proves to be credit worthy, the factor will typically extend the financing. The borrower can have sub-par credit or no credit at all and still be approved for this source of money.

Collateral

Banks typically require applicants to have collateral to put up against their loan. Whether it is the equity in their home or the contents of their store, business owners must have something of value to guarantee the loan. If they lack sufficient collateral, a bank may turn them down. However, with factoring, borrowers offer their invoices as collateral instead. The factor buys the invoices and provides the money quickly to the borrower; the money can then be used to place a manufacturing order or some other business-related purpose. The borrower is not required to sign over the equity in a home or put a car up as collateral against the financing. This individual can avoid worrying about losing his or her house or car if, in the rare case, the invoice customer defaults or is late on payments.

Payments

People who are approved for business loans through a bank can typically expect to repay the principle and interest gradually over a series of months or years. Every month without fail, they must make the payment or face defaulting on their loan. However, people who receive money through factoring can avoid the monthly payments that prove to be such a burden to so many business owners. Once the factoring agreement has been satisfied, such as a manufacturing order being filled, the factor can deduct its fees and pass along the rest of the profit to the client. In many cases, clients still make a handsome profit, despite the fees and other costs being deducted from the total paid by the manufacturer. Once the amount has been satisfied, the borrower is released from the financing agreement and can continue with his or her business concerns.

With the economy still recovering, many business owners find it somewhat of a challenge to get the financing they need to run their businesses successfully. They cannot place orders, build their client bases, or increase their profitability when they lack the money that they need. Even so, many banks are still wary about extending lines of credit to small business owners. They fear that the loans will go into default or that business owners lack the collateral needed to secure the financing. Rather than go without the cash they need, business owners can obtain secure financing and avoid putting up their prized assets as collateral. They can place orders, grow their businesses and remain profitable through factoring. They can also make the wisest decision for their financial circumstances by knowing the key differences between factoring and traditional bank loans.

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