Factoring vs Contract Line of Credit
Factoring and a contract line of credit advance against the same asset, which is why they get confused. Tony Gray and Matthew Gillman compare them side by side: what each advances against, how the fees accrue, what you can draw, and what the difference costs on one invoice.
Are factoring and a contract line of credit the same thing?
Matthew Gillman: Both look at a similar asset, which is why people confuse them. The difference is how it is treated. A contract line looks at the pool of receivables: multiple invoices on one contract or across several, with diversified revenue. Factoring is normally invoice by invoice: you sell an invoice and receive an advance against it. Not everyone qualifies for a contract line, and some companies belong in factoring.
How do the fees differ?
Matthew Gillman: Factoring generally charges a fixed fee for a block of time, such as 30 days on a 30-day invoice, sometimes with additional fees accruing after that. A contract line works like a bank line: you are charged on what you use, while you use it. If you draw today and the invoice pays in a week or two, you pay for a week or two. With factoring you might pay for 30 days of money and only need it for a week or two.
When do I get the money?
Matthew Gillman: With factoring, you bill the government, load the invoice into the factor’s system, and the factor advances against it. With a contract line, loading invoices builds a borrowing base. Ten invoices of $10,000 give you $100,000 of collateral, but you do not have to draw anything. You draw $20,000 or $50,000 when you need it, and you pay only for what you use.
What can a contract line advance against that factoring can’t?
Matthew Gillman: Factoring advances against completed and billed work. Take a janitorial contract: you work September and bill on October 1. But payroll falls on September 15 or 22, after weeks of work you cannot bill yet. A contract line advances against that earned but unbilled revenue. If you start a $300,000-a-month contract with $200,000 a month of payroll, how do you make payroll before the first invoice? Many growing companies cannot, because their profit is trapped, and the faster they grow the worse it gets.
The revenue is earned. People did the work; it just cannot be billed yet, and in government work you generally cannot bill more often. A contract line can also cover mobilization, a third bucket, when a contract has to get started.
Tony Gray: So the difference is timing: factoring funds once you invoice, and a contract line can fund the work as you perform it.
How do I repay factoring or a contract line?
Matthew Gillman: Unlike a term loan or a mortgage, neither has monthly payments. In both, the facility is repaid when the invoice pays.
Which costs less on the same invoice?
Matthew Gillman: Take one contractor with a $100,000 invoice and a $50,000 need, with a 90% advance rate either way. On a contract line, they draw the $50,000 they need and can draw more next week. With factoring, they receive $90,000, because that is how the agreement works: $40,000 more than they needed, and they pay for it.
Say the headline rate is the same on both, charged monthly on the line and per 30-day block on the invoice. The invoice goes in on the 9th and pays 21 days later. On the line you pay for $50,000 for 21 days. With factoring you pay the full fee on the invoice. In our example the contract line cost roughly a third of what factoring did, and the gap grows as you add zeros.
Tony Gray: That is not to say one is better. If you needed the other $40,000 for the business, taking the full advance might be a good thing. It comes down to your working capital needs.
Matthew Gillman: Both solve timing. Factoring can be great if you only want to factor one customer or one invoice. For lower cost and more flexibility, a contract line lets you take what you need when you need it, but it requires a profile: breaking even or making money, good financials and sound internal practices.
What are the main differences between factoring and a contract line?
Matthew Gillman: A contract line is against your whole pool of receivables; factoring is invoice by invoice. On a line you draw what you need; with factoring you take a fixed percentage of the invoice. On a line you are charged on what you use while you use it; with factoring you are typically charged for a block of time regardless of when the invoice pays. And a line’s availability includes buckets beyond invoices: earned but unbilled revenue and, depending on the industry, mobilization.
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This is an edited version of the conversation: spoken repetition is removed and each answer leads with its point. Every figure and example is as said in the episode. For financing specific to your business, talk to us.
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