Factoring vs. a line of credit

A line of credit is the closer comparison to factoring than a term loan is. Both are there for working capital, both are used repeatedly rather than once, and both are meant to cover the gap between paying for work and being paid for it. The differences are narrower and, for a growing business, sharper.

A ceiling versus a percentage

A line of credit is a number somebody agreed to. You can draw up to it and no further, and that number was set against the business as it looked when the line was approved.

Factoring is a share of what you invoice. There is no fixed ceiling in the same sense: the amount available moves with the invoices you raise to customers who pay their bills.

That distinction is invisible when trading is flat and obvious the month you double. A business that wins a contract twice its usual size can hit the ceiling on its line and have nowhere to go until the bank re-underwrites it — which takes exactly as long as it took the first time.

What gets examined

A line of credit is underwritten on your business: accounts, trading history, often a personal guarantee and a charge over assets.

Factoring is underwritten on your customers’ ability to pay. The invoices are the security, because they are what gets collected.

Reviews, covenants and the annual conversation

Lines of credit are typically reviewed on a cycle, often yearly. They can carry covenants — conditions about ratios or performance that, if broken, allow the lender to reduce or withdraw the facility.

The practical risk is not that a bank is unreasonable. It is that a line can shrink at the moment the business looks worst on paper, which is frequently the same moment it is most needed.

Factoring has no equivalent annual renegotiation. Each invoice stands on its own customer’s credit.

How the money arrives

A line of credit is drawn: you move money out of the facility when you need it, and the balance sits there accruing interest until you repay it.

Factoring is per invoice: you submit an invoice and receive an advance against it. When the customer pays, the rest follows, less the fee. There is no balance sitting against you between times.

Cost

A line of credit charges interest on the balance drawn, usually plus a fee on the undrawn portion for holding the facility open.

Factoring charges a fee per invoice, usually tied to how long it takes to be paid. No invoices factored in a quiet month means no fee.

Neither is universally cheaper, and anybody who tells you otherwise is selling one of them. A line of credit that is mostly undrawn is an expensive way to hold an option. A heavy factoring month on fast-paying customers can cost less than the interest on an equivalent drawn balance. The only way to know is to run both against your own invoices.

The collections difference

This one is not about money and it is often what decides it.

With a line of credit, chasing customers is still your job. Somebody in your business spends time on the phone about invoices.

With factoring, the factor collects. That is time off your desk, but it also means a third party is contacting your customers. Whether that matters depends on your customers and on how it is done, which is worth asking about specifically — some arrangements are confidential and the customer never knows the invoice was sold.

Which suits which business

A line of credit tends to suit a business with a settled trading history and predictable needs, where the facility is a buffer rather than the engine — covering a seasonal dip, smoothing a quarter.

Factoring tends to suit a business where the constraint is the gap between delivering and being paid, especially one growing faster than a bank will re-underwrite it, and especially one whose wage bill lands weekly while its customers pay monthly.

Using both

Plenty of businesses run both, and lenders are generally used to it. What matters is that each knows about the other: a line of credit secured against receivables and a factoring agreement over the same receivables is a conflict that has to be sorted out in the paperwork, not discovered later. If you have an existing facility, say so at the start of the conversation.