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Business banking: Asset-based loan and factoring, two different financial facilities
Asset-based loans are often confused with factoring. If it is true that these two types of business finance have a few things in common, they should not be mistaken for each other because at the bottom of it, there are fundamental differences. Understanding the fundamentals of these two financial facilities for businesses makes it easier to see why there are different, notably with regards to their respective borrowing bases, costs, risk levels and due diligence, and even more fundamentally, with regards to customer relations.
Understanding the fundamentals
Asset-based loans and factoring are two types of financial facilities using assets such as receivables as collaterals.
What are asset-based loans?
Asset-based loans use company assets as collateral - generally, quickly-moving assets such as inventory and accounts receivables. Outstanding invoices are the most common type of accounts receivables. The facility can cover a fraction of the value of these invoices - usually, from 75% to 90%. Asset-based loans can be arranged as lines of credit, to finance ongoing capital expenses.
What is factoring?
Invoice factoring is another kind of business finance which uses outstanding invoices. Liquidities released by the financial services provider also typically cover up to 90% of the value of the submitted outstanding invoice. Just like asset-based loans, factoring addresses cash flow problems met by fast-growing businesses with a stable flow of revenue. One key difference can already be spotted between the two, as factoring implies that the outstanding invoices be actually sold to the financial services provider, while they are simply used as collateral in the case of asset-based loans. Factoring arrangements simply are not a type of loan.
How asset-based loans and factoring differ
The fact that asset-based loans use the invoices as collateral, and that these invoices are simply purchased by the financial services company in a factoring arrangement implies many differences.
Borrowing base and costs
Asset-based loans require a much larger borrowing base, at least in the five-digit range, while factoring is much more flexible. As a result, loans are cheaper than factoring because only an APR has to be paid.
Due diligence and risk level
Due diligence requires loans providers to spend a lot of time reviewing financial foundations of their clients - which may include visits to their offices, which comes with a fee. This is because the risk level is higher in case of a loan - with factoring, the only risk is that the invoices don’t get paid, but the financial services provider has every power to do whatever it takes to collect payments, as it owns the invoices.
This last element makes a key difference between asset-based loans and factoring, as with factoring, customers of the business which required the financial facility will know that a third party has entered the transaction. Business owner who are worried about the impact of third-party debt collection on the commercial relationship they have with their clients should think twice about factoring.