What Is the Difference Between Asset-Based Lending and Factoring?
Understanding your short-term credit options as a small business operator can be confusing, especially when so many products use similar terms in different ways. It’s common to see factoring described as financing your assets to get money, so it’s not surprising at all to see some entrepreneurs having trouble distinguishing between that and asset-based lending as a genre of credit. It’s vital to understand how they differ if you use either, though, because you might want to pivot from one to the other as your business needs change.
Factoring is basically financing your invoices. It’s possible to finance purchase orders or to factor agricultural crops, providing an advance against harvest. Both exist, and agricultural factoring was one of the earliest uses of this form of financing. It’s quite useful, and it involves getting an advance against money you are owed so you can use it for cash flow until payment comes in. Modern factoring arrangements tend to involve the lender taking over collection of payments, so you can use them to outsource your accounts receivable.
Asset-based lending is a different product entirely. It involves setting up a credit line that flexes according to the balance of your assets. Instead of outsourcing your accounts, it takes into account the balance of your invoices and inventory, as well as equipment and other assets. Then, the lending program you are with calculates an available credit balance based on the equity available through all your assets. It requires more work to set up and administrate than factoring, but it also provides access to renewable credit you can draw on whenever a balance is available, without having to apply for a new advance every time.
Setting up asset lending takes some time, and you have to open your books to the lender so they can monitor the values of your assets and adjust your credit accordingly. Some entrepreneurs dislike this, so it’s not a financing method for everyone. It is powerful when used as a cash flow management resource, though, and once in place it is more readily accessible than a new factoring arrangement. At the same time, factoring is faster to get initial approval and cash disbursement from, so if you have short-term needs that popped up to surprise you, factoring is probably the better choice to deal with the immediate scenario. Using each at their proper times can ensure you have access to the working capital you need whenever you have outgoing expenses.