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common misconception is that accounts receivable (AR) Factoring is the same as the AR financing. The truth is that the two are very different and would often be used in different situations. The article below is a brief description of the two teams and also provides insight into when you could use one over the other.
AR Factoring, also known as invoice discounting or factoring, consisting of companies that sell receivables to a third party, known as Factor. The Factor collects the money (in many cases). The element of compensation because they do margin off of the amount they give business and the amount they collect from the client. The company benefits because you get immediate cash flow.
Usually Factor will pay anywhere from 60-90 percent up front for the accounts of the company. Then the money is collected, they refer by 10-40 percent minus the service fee. The service as Factor makes its money. The fee is usually between 1-5 percent per account per month. It does not take much math to see that this can be an expensive way to finance.
Now that we have discussed factors let’s take a look at what accounts receivable insurance is. AR insurance is similar to regular insurance so you pay an insurance premium to help you in case things get really bad. Instead, health or housing, you are insuring that the company will still receive money even if customers decide to pay.
As is always the case with insurance can be abused. Andi idea is that you are insuring against something that you do not happen, but could nevertheless. However, if you know that your customers are not going to pay you buy AR insurance so the insurance company has to eat the money, it would probably be unethical. Not to mention that you would probably not be able to get away with it (insurance companies have ways to make sure such an incident does not occur).
Now when you see the difference between accounts receivable insurance and factoring, you can probably see that you would use them under different conditions. Factoring would be a better choice in cases where the business is strapped for cash, but you expect to be able to bounce back pretty quickly. You would use short-term insurance in situations where you want to be careful.
One example already accounts receivable insurance (also known as the compromised credit insurance) might be useful if your company is about to make a huge sale for the first time customers. With first-time customers you have no history of whether they will make their payments and insuring himself was both ethical and potentially a good idea.
Another time when trade credit insurance could be useful if you company is considering opening a credit to new customers and you are not exactly sure what the answer will be. To be just a tad more aggressive with the credit policy can often lead to more sales. Make sure the insurance receivables know what you’re doing, but to get some coverage might not be a bad idea in this situation.
It sums up our discussion of the difference between these two accounts methods. Factoring is used to help out with cash and insurance is used as a precautionary measure.
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