There are plenty of options out there for a business in need of some financial help, from loans to business cash advances to factoring. The problem is that they all appear to be similar in what they offer and the requirements they have; so much so, that it can become quite confusing when trying to discern between them.
In order to clarify things a bit, you might want to start with what is a business cash advance, and then look into a business cash advance: how does it differ from a bank loan. For now, we're going to discuss the difference between loans, advances and factoring.
How Are Loans, Cash Advances, And Factoring Similar?
Let’s start with what the three options have in common: they are all financing types for businesses. Each and every one of these options can be suitable for a business’ financial needs, depending on their specific circumstances and interests. The amounts they offer are similar, although certain options will extend larger loans than others, depending on your circumstances.
Loans – How They Differ From Cash Advances And Factoring
What is a loan?
A loan is an amount of money you borrow from a financial institution or an individual, usually to be repaid with added interest later. The terms of the loan (amount, repayment time, repayment schedule, etc.) must be agreed upon by both parties before completing the transaction.
What makes it different?
Loans differ from the other two options through the simple fact that they are loans. While you still receive money from someone else, the other two options are different types of financing. The other crucial difference is that financial institutions that grant loans ask for more security measures than the other types of financing.
While other kinds of financing are unsecured, banks also offer secured loans, assuming that you have the assets to put up as collateral. Getting a loan might also require a credit check, proof of income over a specific threshold, or otherwise, having someone to co-sign the loan with you and act as a guarantor in case you become unable to repay your debt.
The advantage of a secured loan is that it offers a higher amount of money. Concerning repayment, it is consistent, as it is made by the borrower, in fixed instalments. However, this means that you might find yourself in a position where you cannot afford to repay the sum.
Cash Advances – How They Differ From Loans And Factoring
What is a cash advance?
A cash advance loan for small businesses is money one receives not as a loan, but as an advanced payment from money they are owed or that they stand to earn later, usually to ensure cash flow. While this is not a loan, interest is still repaid, usually at a higher rate than regular loans. Repayment of advances is also different from loans and factoring.
What makes it different?
One of the most important idiosyncrasies of cash advances is the way the loan is repaid. A business that wants an advance needs to have a decent amount of credit card transactions and income from credit card transactions every month. That is because instead of repaying the money in fixed instalments every month, the payments are made based on a fixed percentage of each day's credit card income.
The payments are made automatically, as the merchant cash advance provider has access to the business’ account. Because the instalments are not fixed, the aspect that makes advances different than the other options is the flexibility it offers in terms of repayment. Let’s say the holdback percentage is 15%. If more sales are made in a day, the amount repaid will be higher, while fewer sales result in a lower repayment. Essentially, you will only ever pay 15% of whatever you make, thus ensuring you can always afford the repayment amount.
Factoring – How It Differs From Loans And Cash Advances
What is factoring?
Factoring is a financing option that is not a loan, and that consists of selling an invoice at a discount to a spot factoring company in order to ensure cash flow flexibility. Businesses invoice clients, but it can often take several months for them to pay for the services provided. In the meantime, the business might struggle with cash flow.
In that case, they can sell the invoice to a third party, who will pay the business a majority of what they are owed (around 70% to 80%, depending on the company), retaining a percentage as payment. When the client pays the full amount to the factoring company, the latter pays the business the rest of the full sum (so around 20% to 30%), except for any fees they charge.
What makes it different?
Clearly, factoring is different because it doesn’t involve borrowing money; it’s more akin to an advance, in this respect, or transfer of debt. In addition, this is a medium-term collaboration. Not short-term, like a cash advance for business, but not as long-term as a bank loan. Generally, a contract will be made for 24 months, a time during which the factoring company handles sales ledgers.
This option is especially suited to small businesses or businesses that are just starting up. These, in particular, may need help getting cash flow in order to be able to attract other clients or work on other projects while they wait for their clients to fulfil the requested payment. For more information and financial help for start-ups, check Gov.uk.
Here are the best companies that offer factoring services in the UK:
- Lloyds Bank
All in all, each of the three options brings something different to the table and is, thus, suitable for different businesses with different needs. Hopefully, you’ve been able to see what the similarities are, but also what differences they present, so that you can make an informed decision on which option is best for you and your business.