A excellent method to describe the distinction is as follows.
In contrast to the early payment discount
The early payment discount that many businesses provide to their clients is the most accurate analogy for invoice factoring. 2/10 Net 30 are the customary terms for early payments. This means that if payment is made within 10 days of receiving the invoice, the customer may deduct 2% from the invoice's face value. Otherwise, they have 30 days to pay the full amount.
Invoice factoring performs just this without giving the customer the option to accept the discount. There are benefits to using this strategy. One is that the idea of a discount does not become second nature to the end user. Therefore, the 2% flows straight to the bottom line when a corporation no longer needs to factor its invoices.
Here is another compelling argument in favor of factoring. Some businesses will not accept the 2% reduction that is being given and will still pay within 30 days. This totally defeats the point of providing the discount.
These two detrimental effects are removed by factoring.
Comparative Analysis of Accepting Credit Card Payment
Invoice factoring, at its most basic, is a way for a business owner to get quick payment from clients who can't or don't want to pay with cash. This is accomplished in the realm of consumer-based enterprises (and some commercial transactions) by taking credit card payments. From 1.75 to 4 percent of the transaction amount is levied as the merchant processing fee for credit card payments. The actual transaction cost is affected by the type of card, the bank, the volume, etc.
For instance, Square charges a fee of 2.75% for each transaction. [Square is the business that enables the use of a computer, tablet, or cell phone as a credit card processing device.]
Another procedure that relies on transactions is invoice factoring. The service charge on a typical invoice factoring transaction would range between 2% and 2.5%. (depending on the specifics of the transaction). This is less than accepting a credit card as payment.
Compared to lending from banks
The distinction between renting and buying exists between factoring and bank loans. A rental fee is what banks charge. When you borrow money from a bank (or use a line of credit), you are required to pay it all back plus a little extra. The interest rate is that extra amount. This is comparable to the cost of hiring a car. You must return the device once you've finished using it and pay the usage fee. The same is true of bank loans. The use of the bank's funds is permitted, but you are required to return them after usage and pay a fee.
Since you did not borrow any money through invoice factoring, you owe nothing. An invoice that is a part of your company's accounts receivable has been sold by you to the factoring company. The A/R report typically contains several delinquent invoices at once. That asset (the invoice) depends on your client upholding their end of the bargain when it comes to paying for goods and/or services. Because of this, the factoring company receives payment when your customer fulfills their contract.
It takes a special calculation to convert a discount rate (like the above-mentioned early payment discount) to an interest rate. It is not easy to understand. Because the ""discount"" is applied against revenue rather than a fixed borrowed amount, multiplying the discount rate by 12 months does not reflect the true cost of money. On the other hand, a borrowed sum is subject to an interest rate.
Let's say, for illustration, that the factoring company receives $100,000 worth of invoices each month. Let's further assume that each invoice will receive a 2.5% reduction. [That is, incidentally, on the high side.] Future revenues of $1,200,000 would be sold to the factor after a year. The price of the money would be $30,000. [2.5% of $100,000 = $2,500 multiplied by 12] equals $30,000.
You should multiply the interest rate of the lender's offer by $1,200,000 to determine the comparative value of borrowed money. This is how it seems. For instance, The Lending Club recently offered an interest rate of ""as low as"" 5.9% annually. With a 5.9% interest rate, the annual cost of borrowing $1.2 million would be $70,800. The cost of money would be $30,000 if that revenue were taken into account.
Summary
Looking at the financial transaction from a different angle is necessary to distinguish between an interest rate and a discount rate. Cost of money is not a comparable term. It is not in the owner's best interest to choose between the two financing types based only on cost of money. The choice is preferable based on other factors, as mentioned in earlier articles in this series:
Is the company even eligible for bank financing?
Should the company hold off on taking on further debt at this time?
Does the owner lose their independence when they borrow money or receive additional equity?
Financing is a short-term condition, whether it comes from bank lending or invoice factoring. It acts as a growth-supporting factor for companies. As a result, a firm owner should weigh their alternatives in light of the current business climate and select the option that will help them advance the most quickly.""" - https://www.affordablecebu.com/
