Last Updated May 15, 2025
Cash flow is a must for any company, but most small business owners don’t have thousands of dollars in their bank accounts. Fortunately, when your business needs working capital, there’s no shortage of financing options.
Two of the most common financing methods for businesses in need are accounts receivable factoring and inventory financing. Both options improve cash flow, but through different processes and with different benefits and risks.
In this guide, you’ll learn the key differences between accounts receivable factoring vs. inventory financing, how each option works, and when to use factoring vs. inventory financing, depending on your business needs.
What Is Accounts Receivable Factoring?
Accounts receivable factoring, also known as invoice factoring, is a type of financing that allows businesses to convert outstanding invoices into immediate cash. Instead of waiting 30, 60, or even 90 days for a customer to pay, you sell your invoice to a factoring company at a discount. In return, the factoring company gives you a large portion of the invoice’s value, sometimes within 24 hours.
The upside to AR factoring is that you can use the funds however you see fit, whether it’s to cover operations, payroll, or invest in new opportunities. Unlike traditional loans, accounts receivable factoring isn’t based on your credit score but on the creditworthiness of your customers.
Factoring differs from inventory financing because it uses a different type of collateral to secure your loan. With factoring, the asset is your unpaid invoices, whereas with inventory financing, it’s the products sitting in your warehouse.
How the Factoring Process Works
Factoring is a straightforward process that can often provide funding in as little as a day. Most invoice factoring companies follow this process:
- Submit an invoice: You can send one or a batch of invoices to a factoring company. There’s no obligation to send invoices regularly; you only send them when you need financing.
- Get an immediate cash advance: The factoring company verifies the invoice and advances you a percentage, typically 80% to 90% of the total invoice value.
- The customer pays: Your customer pays the factoring company directly, in accordance with the original invoice terms.
- You receive the rest of the payment: Once the customer pays in full, you receive the remaining balance, minus the factoring fee.
Compared to inventory financing, factoring provides more immediate liquidity, especially when your inventory turnover is slower or less predictable. Factoring offers your business cash based on money you’ve already earned, making it an attractive, debt-free financing option.
Why Businesses Need Factoring
From late-paying customers to gaps in cash flow, there are many reasons businesses turn to factoring. It has many benefits, including:
- Better cash flow: Instead of waiting for customers to pay, you get most of your invoice amount up front. This helps you meet payroll, purchase supplies, or invest in growth without delay. With AR factoring, you can take on new contracts, expand your team, or boost production, even if your cash is tied up in receivables.
- Zero debt: AR factoring isn’t actually a loan. Unlike loans, factoring doesn’t add liabilities to your balance sheet. That makes it a smart solution for companies trying to maintain clean financials and no debt.
- Flexibility: Approval is based more on your customers’ creditworthiness than your own. That makes accounts receivable factoring accessible even to smaller businesses and startups.
Risks Associated With Factoring
While there are lots of benefits to factoring, it isn’t a perfect solution. Like any form of financing, factoring does have some trade-offs, like:
- Fees: Factoring companies charge fees in exchange for their services. Most fees are a percentage of the total cost of the invoice and are relatively affordable, but they can add up over time if you rely on factoring too much.
- Strained customer relationships: Because your factoring partner will often communicate directly with your customers for payment, there’s a risk of damaging relationships, especially if the factoring company is aggressive in its collections.
- Eligibility: Not all customer invoices qualify for factoring. If your customers have poor credit or irregular payment histories, you may not get approval for the funding you need.
How to Qualify for Factoring
Selling accounts receivable is a quick way to finance your business, but you need to qualify for factoring. Factoring companies typically assess factors such as your debtors’ credit score. Since the factoring company is relying on your clients to pay their invoices, their credit scores are more important for qualification than yours. The fact there is no minimum credit score required to qualify is another perk.
Additionally, most factoring companies won’t accept invoices addressed to individual consumers; they usually specialize in business-to-business invoices only. So, they will analyze your AR aging report to help them with the underwriting process. Lenders prefer businesses that invoice regularly and have a track record of on-time payments.
What Is Inventory Financing?
Inventory financing is a type of asset-based lending where a business uses its unsold goods as collateral for a loan. This financing option is helpful if you need to purchase bulk inventory before peak season or fulfill large purchase orders without depleting your cash reserves. With this option, funding is tied to physical products in your warehouse, helping you plan for future sales.
How the Inventory Financing Process Works
Unlike invoice factoring, inventory financing requires more steps and approvals from lenders. This form of asset-based lending requires assessing and monitoring physical goods. Here’s how the process generally works:
- Application: First, you apply for inventory financing. The lender requires detailed information on your current inventory, including the type, value, and turnover rate.
- Valuation: The lender reviews your application to assess how sellable the inventory is. Lenders will only extend financing based on qualified stock, so there’s a chance that not all of your stock will count as collateral based on the lender’s criteria.
- Monitoring: Some lenders require ongoing inventory reports to ensure you have viable collateral over time.
Why Businesses Choose Inventory Financing
If you’re in retail, wholesale, or manufacturing, you have large amounts of stock on hand. Inventory financing is a form of alternative lending that provides the capital required to purchase goods in bulk, eliminating significant cash flow gaps. Businesses choose inventory financing to:
- Protect cash flow and buying power: Instead of paying upfront for inventory, you can finance it and reserve your cash for other opportunities. This type of financing also allows you to order larger quantities and negotiate bulk pricing.
- Meet demand: Access to capital enables you to keep shelves stocked and fulfill orders quickly.
Access regular funding: Inventory loans and lines of credit often offer flexible repayment terms that scale with your business.
Risks Associated With Inventory Financing
Inventory financing can help a business fund large-scale projects and grow quicker, but it does have some risks, including:
- Inventory depreciation: If your inventory loses value over time or becomes obsolete, your collateral may no longer be sufficient to cover your loan. Lenders may require frequent audits, detailed inventory reporting, or even access to your warehouse to monitor for depreciation, which can make inventory financing risky in the long run.
- Storage costs: Maintaining inventory requires warehousing, security, and logistics—all of which add to your overhead.
Market volatility: Changes in demand can leave you with excess stock that’s difficult to sell, increasing your financial liability.
How to Qualify for Inventory Financing
Inventory financing lenders want to see valuable inventory and a well-managed business. You can maximize your chances of qualifying for inventory financing through quality inventory with turnover. Lenders want to see inventory that moves quickly and maintains its value. This is why perishable or seasonal goods may be harder to finance.
Further, detailed, up-to-date records help build trust and streamline the approval process. Strong sales and financials, including a consistent track record of customer demand, indicates that your inventory is likely to generate revenue. While inventory serves as collateral, lenders still assess your overall financial health, including your credit score and debt-to-income ratio.
In-Summary: Differences Between Factoring vs. Inventory Financing
Choosing between accounts receivable factoring vs. inventory financing depends on the type of assets your business can leverage and how quickly you need access to capital. Ultimately, there’s no “winner.” The right option for your business depends on various factors.
| Factoring | Inventory Financing |
| Unpaid invoices are the collateral | Unsold inventory is the collateral |
| Receive funding within 24 to 36 hours | Longer timelines because of valuation and oversight requirements |
| Best for companies with large receivables and delayed payments | Best for companies with large amounts of stock or seasonal demand |
While factoring vs. inventory financing offer different benefits, they’re not mutually exclusive. Many businesses benefit from blended accounts receivable and inventory financing strategies to create steady cash flow and unlock working capital across multiple assets.
Michael McCareins is the Content Marketing Associate at altLINE, where he is dedicated to creating and managing optimal content for readers. Following a brief career in media relations, Michael has discovered a passion for content marketing through developing unique, informative content to help audiences better understand ideas and topics such as invoice factoring and A/R financing.
