Maintaining healthy cash flow is a constant challenge for many businesses. Late payments, seasonal drops in revenue, or a surge in orders can all put pressure on your working balance. When that happens, two common financing tools stand out : factoring and working capital loans.
This article breaks down how each solution works, what types of companies benefit the most, and which risks or costs to consider. If your business is exploring funding options to improve cash flow or cover financial needs, understanding the difference between these two tools can help you make the right choice.
Understanding Factoring
What is Factoring?
Factoring is a type of financing where a business sells its accounts receivable to a third-party known as a factoring company. Instead of waiting weeks or months for customers to pay their invoices, the company receives a large portion of the invoice value up front. This gives immediate access to cash, which can be used for payroll, supplies, or other business expenses.
Factoring is not a loan. It does not add new debt to your balance sheet, and approval depends more on the quality of your clients’ credit than your own. Read more about how factoring works.
How Does Factoring Work?
Your company submits one or more invoices to a factor. The factoring company typically advances 70 to 90 percent of the invoice value within a few days. Once the client pays the invoice, the factor transfers the remaining balance to your business, after deducting their fee.
This setup helps improve cash flow by turning unpaid receivables into usable working capital. It’s especially useful for companies facing long payment terms or customers who tend to delay payments.
Types of Factoring (Recourse vs. Non-Recourse)
There are two main types of factoring: recourse and non-recourse.
- In recourse factoring, your business remains responsible if the customer doesn’t pay the invoice. If the debt goes unpaid, you must repay the amount advanced.
- In non-recourse factoring, the factoring company assumes the credit risk. If the client defaults, the factor absorbs the loss. This option usually comes with higher fees.
Choosing the right type depends on your risk tolerance and the reliability of your customers. Some companies start with recourse and move to non-recourse once they build a relationship with the factor.
Advantages and Disadvantages of Factoring
| Disadvantages |
Advantages |
| Higher fees than traditional loans or lines of credit |
Fast access to cash without taking on new debt |
| Loss of control over accounts receivable or follow-up with clients |
Turns unpaid invoices into immediate funding |
| May affect relationship with the customer if the factoring company handles payment collection |
Approval is based on invoices, not your credit score |
| Some factoring services require recourse, meaning you’re liable if your client doesn’t pay |
Ideal for small businesses that need fast cash flow support |
Understanding Working Capital Loans
What Are Working Capital Loans?
Working capital loans provide short-term funding to help businesses cover their daily operations, such as paying suppliers, handling payroll, or managing seasonal gaps in cash flow. Unlike loans used for long-term investments, these loans focus on immediate business needs to maintain momentum without disrupting operations.
They do not require you to sell accounts receivable or wait for customer payments. Instead, they inject capital directly into your company, giving you the flexibility to meet urgent expenses or pursue new opportunities. Learn more in our guide to working capital loans.
Types of Working Capital Loans
There are several types of working capital loans, each offering different structures depending on your company’s financial profile and objectives.
- Lines of Credit
This option gives your business access to a revolving credit line. You can draw money as needed, up to a limit, and only pay interest on the amount used. It’s a flexible solution for managing short-term expenses or unexpected costs.
- Term Loans
A term loan provides a lump sum of money that your company repays over a fixed period with regular installments. This structure works well for businesses that need a predictable repayment plan to finance a specific project or recover from temporary cash shortages.
- Government-Backed Loans
Some Canadian financial institutions offer working capital loans supported by government programs like the Canada Small Business Financing Program. These loans can provide longer terms or slightly better rates, especially for small businesses that don’t qualify for traditional financing. The process takes more time and may require additional documentation.
Advantages and Disadvantages of Working Capital Loans
| Disadvantages |
Advantages |
| Stricter credit requirements for approval, especially for newer businesses |
Can unlock larger funding amounts than factoring |
| Longer application process with more required documents |
More control over your accounts and customers |
| May require collateral or personal guarantees |
Fixed repayment terms help plan your cash flow |
| Adding debt can impact your ability to secure future financing |
Suitable for long-term needs like hiring, operations or inventory |
Factoring vs. Working Capital Loans: A Direct Comparison
| Criteria |
Factoring |
Working Capital Loans |
| Speed of Funding |
Fast access to cash, often within 24-48 hours once invoices are verified |
May take several days or weeks due to credit checks and approval process |
| Cost of Funding |
Usually higher due to fees and risk transferred to the factoring company |
Often lower interest rates, especially for businesses with strong credit |
| Eligibility Requirements |
Based on the quality of accounts receivable, not your credit score |
Depends on your credit history, financials, and time in business |
| Amount of Funding |
Tied to the value of invoices; can grow with your sales volume |
Fixed based on financial health and lender limits; may not grow with revenue |
| Impact on Credit Score |
Minimal. The factor evaluates your clients, not your company’s credit |
Can affect your credit score, especially if repayments are delayed |
| Level of Risk |
Lower upfront risk for your business, but you may lose control of collections |
Higher risk due to debt obligation; missed payments can impact credit and operations |
Choosing the Right Option for Your Business
When Factoring Is a Better Choice
Factoring may suit your business if:
- You manage long payment terms and need faster cash flow.
- You want to unlock capital from accounts receivable without taking on new debt.
- Your company struggles with credit, but your clients pay reliably.
- You need immediate access to cash to meet operational needs.
When a Working Capital Loan Is a Better Choice
A working capital loan may be a stronger fit if:
- Your business has a solid credit history and can qualify for better loan terms.
- You prefer full control over your invoices and customer relationships.
- You’re planning a larger investment or expansion and need a fixed amount of funding.
- You’re comfortable with a regular repayment schedule.
