For companies that rely heavily on invoice-generated income, accounts receivable factoring provides a type of short term loan option that otherwise would not be available through traditional banks loans. Factoring companies consider the value of the invoices when working with business, while banks focus more on the business’s total assets before underwriting a loan.
As much of the assets in an invoice-based business are tied up in its receivables, an asset analysis may not bode well for a start-up company or a service-based business. In many cases, banks also require some form of collateral in exchange for a loan, whereas a business’ invoices become collateral when working with a factoring company.
Since the invoices act as the collateral, a factoring company looks at the credit-worthiness of the business’ customers rather than the credit-worthiness of the business itself. As many factoring companies assume the risk of not getting paid for outstanding invoices, the credit-worthiness of a business’ customers holds more importance than that of the business they represent. In effect, the ownership of a receivable transfers from the business to the factoring company.