Although they sound the same, a business line of credit and a factoring line of credit have differences that you need to understand before borrowing from either account. Both borrowing programs can advance your business and help you purchase new equipment, pay employees, and expand your business.
You might have a problem acquiring a business line of credit, however. Difficulties in obtaining a business line of credit are because there are very strict qualification requirements. However, if you are a viable business with a good clientele, these credit options are low-cost solutions since lenders will work with clients considered low-risk.
Factoring lines of credit do have flexible credit terms. The credit limit on a factoring loan is determined by the number of accounts receivable you have and your ability to deliver the product to your clients.
Business Line of Credit
Why is it important to have a business line of credit? First, your business needs a line of credit to have access to short-term funding almost immediately. If you are looking for hlep to support operational expenses, a line of credit is a good way to go. Second, a business line of credit is quite similar to a credit card. You pay on the amount you borrow, and you can keep borrowing as long as you pay the account.
Small businesses face a financial crisis brought on by the coronavirus pandemic or even economic fluctuations. A business credit and financing resource summarize a business line of credit as a tool that is crucial to helping your business take advantage of an opportunity to weather a crisis. You can borrow only what you need up to your credit limit and pay interest on the money you borrowed rather than the entire loan.
Many lines of credit are unsecured, and other lines of credit are secured with assets that you give up to the lender if you fail to pay as agreed. Lenders expect payments weekly or monthly, and payoff time frames can range from a few months to many years. Your payments fluctuate on the amount you borrow. Interest will apply to the amount you finance. For example, if your credit line is $100,000 and you withdraw $20,000, you will only pay interest and payments on the $20,000.
Do be aware that you will need to pay origination, maintenance, and draw fees as you use your account. You can transfer funds from a line of credit into a checking or savings account. All you need to do is use the phone to call your banker, apply online or use a debit card from your lender. If you use an ATM, however, you will pay fees.
The following steps determine your business line of credit. First, use your estimated annual gross revenue or sales and divide by 365. Next, multiply your daily cash by the usage or take your accounts receivable day less accounts payable. This will give you the estimated line of credit you may receive.
Business lines of credit are for business expenditures, and you will repay these loans within a specific amount of time. Therefore, a business line of credit may be better in uncertain times and when you need money immediately.
Factoring Line of Credit
Most businesses will eventually have cash flow problems. These problems may be due to the pandemic, economic factors, employee turnover, or low inventory. A factoring line of credit takes into consideration your accounts receivable. The factoring company realizes that much of your cash flow problems are the facts you may have to offer payment terms to clients. A growing business cannot afford to have clients outstanding for over 30 days. Factoring lines of credit will take as collateral your open client accounts.
A factoring company may advance up to 90% in funds on outstanding accounts receivable. In other words, your credit line would be 90% of your eligible outstanding accounts receivable. You promise your outstanding accounts receivable to a factoring company, and they advance you the funds. However, you will have to pay fees. Check out the fees of different factoring companies to ensure you get the best value.
Qualifying for a factoring line of credit is simple. You fill out an application form, and a factoring company will consider the following:
- Does this business have enough accounts receivable to pay for the loan?
- Do you have account receivables?
The main concerns include how many years you have been in business, the business owner’s credit score, how your account receivable clients pay, and how quickly. But, of course, the biggest concern is the invoice factoring is buying invoices that will get paid.
The factoring company may reject your application due to pre-billed or progress billed invoices. A factoring company does not want to take on the risks or “what if” in the future. The factoring company cannot loan money for a future project or products that are not yet produced.
A factoring line of credit has several different factors that determine the costs. One is how long it takes for your customers to pay and the percentage of the invoice value. However, factoring has flexible credit terms that might be good for your company. The line of credit from a factoring company is set up by your needs, the available cash flow, and your assets. When setting your credit limit, a factoring company considers these elements.
A Business Line of Credit of a Factoring Credit Line?
Each type of credit line has pros and cons, and each will solve a specific set of problems. The rule of thumb for establishing a line of credit is:
- Are you established? Have you been in business for over two years?
- Have you achieved growth maturity?
- Are you growing, and is your business viable?
- Can you provide timely and accurate financial statements?
- Do you have solid assets?
- Can you pay back the line of credit and abide by the covenants?
Requirements in Establishing a Factoring Line of Credit:
- Are you a new business?
- Do you have good clients that will pay within 60 days?
- Are you growing?
- Do you have or have financial problems?
- Can you produce accurate financial reports, or are your reports sporadic?
- Are you out of covenant with a line of credit and need help?
Factoring or account receivable financing is easy. Factoring involves selling your receivables to a factoring company in exchange for cash or a loan. A line of credit is a financing solution that can be below cost and erect for companies that have a track record, solid assets, and a steady cash flow. It does have stringent financing requirements which you may not want to explore.
Look at the pros and cons of both financing options, look at the various companies who lend, and then decide what you want to do. Note that factoring is faster approval, credit flexibility, and a growth structure that will grow with you.
A line of credit is a slower process, your credit does matter, and you have a limited dollar limit. Funding can be almost impossible to be beyond the line of credit you are offered. Again, it is your choice.