Struggling to cover everyday expenses like payroll, inventory, and vendors, or feeling the pressure of a seasonal slowdown? Working capital loans can help you bridge a short-term gap in these situations, but they’re not the only solution. In this guide, we’ll compare factoring vs. working capital loans and other working capital loan alternatives.
Types of Working Capital Loans and How They Work
Working capital loans provide borrowed funds that you can use for day-to-day business expenses. They generally fall into three main categories based on how you receive and repay the funds.
Short-Term Business Loans
A short-term business loan provides a lump sum that you repay with interest over a set period. Payments may be due daily, weekly, or monthly, depending on the lender and loan terms. Once you repay the loan, you must apply again if you need additional funding.
It’s worth noting that just 37 percent of small businesses that apply for a business loan receive full funding, according to the latest Small Business Credit Survey (SBCS). Rigid requirements and limited credit histories often serve as a barrier to financing.
Business Lines of Credit
A business line of credit provides access to funds up to an established credit limit. You can draw money as needed, and interest typically accrues only on the amount borrowed. As you repay the balance, your available credit replenishes, so you can borrow again without submitting a new application.
In all, 45 percent of small businesses applying for a business line of credit receive full funding, per the SBCS. That makes them slightly more accessible than loans but still leaves the majority short of meeting their needs.
SBA Loans
An SBA loan is partially guaranteed by the U.S. Small Business Administration and issued through approved lenders. The guarantee reduces the lender’s risk and can help qualified businesses access competitive rates and longer repayment terms.
Several SBA programs permit businesses to use funds for working capital. Depending on the program and loan agreement, you may receive a lump sum and make scheduled payments or access funds through a line of credit.
Of all the financing types covered in the SBCS, SBA loans have the lowest share of businesses receiving full funding, at just 32 percent.
Common Working Capital Loan Alternatives and Small Business Funding Options
Outside of traditional working capital loans, there are several alternative funding solutions that can help you cover daily expenses.
Trade Credit
Trade credit lets you purchase goods or services from a supplier and pay later. For example, net 30 terms give you 30 days from the invoice date to make payment. No cash changes hands upfront. Instead, the arrangement delays an expense so you can preserve working capital in the meantime.
Trade credit is often the ideal solution for businesses because it generally doesn’t come with interest or fees unless you pay late. However, your ability to secure trade credit may depend on your supplier relationships, and not all are willing to wait for payment.
Invoice Financing
Invoice financing, also known as invoice discounting or accounts receivable financing, lets you borrow against unpaid customer invoices, meaning your invoices serve as collateral. If you’re comparing invoice financing vs. a term loan, they can work in much the same way, where you receive a lump sum and pay it back with interest. However, some agreements work more like a revolving line of credit. You’ll also typically pay more for invoice financing than you would for a traditional business loan.
It’s important to note that invoice financing is a different type of funding for slow-paying invoices than invoice factoring, which we’ll cover in just a moment.
Business Credit Cards
Business credit cards provide revolving credit for purchases, bills, and other eligible expenses. You must make at least the minimum payment each billing cycle, and interest generally applies to balances carried beyond the grace period. Cash advances may also be available, although they typically carry separate fees and begin accruing interest immediately.
In all, 62 percent of small businesses say they use credit cards regularly, per the SBCS. Meanwhile, 24 percent aren’t confident in their ability to pay off their cards without paying interest, QuickBooks surveys show. This, paired with the higher interest rates and fees typically associated with credit cards, is why so many small businesses find themselves in a debt spiral once they start leveraging their cards.
Merchant Cash Advances
A merchant cash advance (MCA) provides an upfront payment in exchange for a portion of your future sales. The provider collects the amount owed through fixed withdrawals or a percentage of daily or weekly sales.
Costs are generally calculated using a factor rate rather than an interest rate, which can make it difficult for business owners to understand the true cost of an MCA loan before signing up. When converted into an annual percentage rate (APR), however, many climb well into the hundreds. Frequent withdrawals can add another layer of pressure on your cash flow until the advance is paid in full.
How Invoice Factoring Works
Invoice factoring, also referred to as accounts receivable factoring, lets you sell open business-to-business (B2B) invoices to a factoring company, also called a factor, in exchange for immediate cash. Rather than repaying the funds through scheduled withdrawals, your customer pays the factor directly when the invoice is due.
The Invoice Factoring Process
While every factoring company is different, most follow a process like the one outlined below.
- Approval: You apply with a factoring company, and they review a few common business documents. It’s typically much easier to qualify for factoring than traditional financing because their primary concern is the payment history of your customer, as they’re the one paying the invoice.
- Submit Your Invoices: Work like you normally do. When you invoice your customer after goods or services are delivered, you’ll also send a copy to your factoring company. The factor then verifies the invoices.
- Receive Your Advance: Once approved, you typically receive 70 to 90 percent of the invoice value upfront. At Charter Capital, we offer advances up to 98 percent of an invoice’s value.
- Move Forward: Because your factor manages collections on all factored invoices, there’s no need for you to chase payments.
- Receive the Residual: Once your customer pays, you receive the remaining funds minus your factoring fee.
Invoice Factoring vs. Working Capital Loans: A Short-Term Business Capital Comparison
Invoice factoring and working capital loans can both provide the cash you need to cover operating expenses. However, factoring converts money you have already earned into immediate cash, while a loan gives you borrowed funds that must be repaid.
| Invoice Factoring | Working Capital Loans | |
|---|---|---|
Funding Source | Open B2B invoices | Borrowed capital |
Qualification Focus | Your customer’s payment history | Your business and personal financials |
| Speed of Approval and Funding | Days | Weeks or months |
| Funding Availability | Can grow with your business | Based on approved loan or credit limit |
| Repayment | Your customers remit their invoice payments to the factor; there’s generally nothing for you to repay | Your business repays the lender |
| Cost | Usually much more affordable than alternatives like MCAs, but typically more costly than bank or SBA loans | Traditional bank and SBA loans tend to be among the most affordable options; alternatives like credit cards and MCAs are often quite expensive |
| Business Debt | Generally does not create debt | Adds debt to your business |
Customer Involvement | Customers pay the factor | None |
Funding Source and Structure
With factoring, you sell open B2B invoices and receive most of their value upfront. The factor purchases the invoices, your customer pays the factor, and you receive the residual minus the factoring fee.
A short-term loan provides a lump sum, while a line of credit lets you borrow against an approved limit. In both cases, your business receives money from a lender and assumes responsibility for repaying it.
Qualification Requirements
Working capital lenders typically review your business and personal credit, revenue, cash flow, existing debt, time in business, and available collateral. Requirements vary by loan product and lender, with traditional bank and SBA loans generally requiring more documentation and stronger financials.
Factoring companies focus primarily on the payment history and creditworthiness of your customers. Your own credit and time in business still receive consideration, but they carry less weight. You will also need eligible B2B invoices for completed work.
Funding Speed
Traditional working capital financing often takes weeks or months from approval to payout, while bank and SBA loans usually require more documentation and a longer underwriting process, so they’re often even slower.
Factoring can move more quickly because the factor is evaluating your customers and invoices rather than conducting a traditional loan review. Once you are approved and your account is established, Charter Capital typically provides same-day funding on verified invoices.
Available Funding
A term loan gives you a predetermined amount, while a line of credit limits borrowing to the amount your lender approves. Accessing more capital may require another application, updated financial documents, or a new credit review.
Factoring availability is tied to your eligible invoices and the credit limits established for your customers. As you complete more work and generate more approved invoices, your access to funding can grow alongside your sales.
Repayment
Working capital loans require payments according to the schedule in your agreement. Depending on the product, payments may be collected daily, weekly, or monthly from your business cash flow. You remain responsible for those payments even if the expense you funded does not produce revenue as quickly as anticipated.
Factoring does not create scheduled loan payments. Your customer pays the factor according to the invoice terms. Under a recourse agreement, however, you may need to replace or repurchase an invoice if the customer does not pay.
Cost
Loan costs are generally based on an interest rate applied to the outstanding balance. Origination fees, draw fees, maintenance fees, and prepayment penalties may increase the total cost.
A factoring company charges a percentage of the invoice value. The fee may be fixed or increase based on how long the invoice remains open. When evaluating factoring rates vs loan interest, compare the total dollar cost, the length of time you will use the funds, and any services included. Charter Capital’s factoring rates are typically between one and three percent and include collections and customer credit checks.
Debt and Credit Impact
A working capital loan adds debt to your business and creates an ongoing payment obligation. It may also affect your borrowing capacity. If the lender reports to business credit bureaus, timely payments may help build credit, while late or missed payments may damage it.
Factoring is generally structured as a sale of receivables rather than a loan, so it does not add a loan balance or scheduled debt payments. It typically does not help you establish a loan payment history either, although many growing companies build up their credit score because small business factoring allows them to make more timely payments.
Customer Involvement
Working capital loans generally have no impact on your invoicing process. Your customers continue paying your business and do not interact with your lender.
With factoring, your customers receive notice that factored invoices should be paid directly to the factor. This is called a notice of assignment (NOA). The factoring company also manages collections on those invoices, much like an outsourced billing agency might do; customer service remains a priority.
When Working Capital Loans May Be the Better Cash Flow Solutions for SMEs
A working capital loan may be a better fit when you can comfortably take on debt and want to keep your customer payment process unchanged. The specific advantages will vary by loan type, but financing may make more sense in the following situations.
You Do Not Have Eligible B2B Invoices
Factoring requires open invoices from creditworthy business or government customers. A loan may be more suitable if you sell directly to consumers, collect payment immediately, or have not generated the invoices needed for factoring.
You Qualify for Favorable Terms
Strong credit, steady revenue, and an established operating history may help you secure a competitive interest rate and manageable repayment schedule.
You Need Funding Upfront
A loan can provide capital before you complete the work or generate an invoice. This may be important when you need to purchase inventory, prepare for a busy season, or cover the upfront costs of a new project.
You Can Wait for Funding
It can take weeks or months before you even receive an approval decision on bank loans, lines of credit, and SBA loans. If you need a working capital solution fast, you aren’t likely to find it through traditional sources.
You Can Manage Scheduled Payments
Loans require payments regardless of when your customers pay you. They may be a practical choice when your cash flow is consistent enough to support the additional obligation.
When Factoring May Be the Better Choice for Working Capital
When weighing invoice factoring vs. a business loan, factoring may be the better fit if unpaid B2B invoices are creating cash flow gaps and taking on debt would add more pressure. It can be especially helpful in the following situations.
Your Customers Take Too Long to Pay
If you’re trying to decide whether to choose a factoring company or loan for cash flow concerns, factoring is an easy win. It converts invoices into immediate cash, so you can cover expenses without waiting for payment.
You Need Funding Quickly
Factoring typically has a faster, simpler approval process than traditional financing. Once your account is established, Charter Capital can provide same-day funding.
Your Credit or Time in Business is Holding You Back
Factors place greater emphasis on your customers’ payment history than your personal or business credit. This can make factoring more accessible if your credit history, revenue, or time in business makes it difficult to qualify for a loan. Even startups can qualify for factoring as long as they have customers with established payment histories.
Your Business is Growing Rapidly
Taking on larger orders or contracts often creates expenses well before the related invoices are paid. Because factoring availability can increase as you generate more eligible invoices, it can provide additional working capital as sales grow.
You Want to Avoid Scheduled Loan Payments or Debt
Your customers pay the factor when their invoices are due, so you do not have to fit daily, weekly, or monthly loan payments into your cash flow. You also don’t accrue debt, which can be helpful when you want to preserve your credit line for other things.
Collections Are Taking Up Too Much Time
Charter Capital manages collections on factored invoices at no additional cost. This frees your team to focus on customers, operations, and growth.
Unlock the Working Capital Trapped in Your Invoices with Charter Capital
As America’s leading invoice factoring company, Charter Capital has been serving businesses across the nation for over 25 years. Whether you’re prioritizing accessibility, speed, or service, or actively comparing quotes, we can help. Connect with us for a no-obligation rate quote.
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