AR Factoring vs a Line of Credit: What Each One Actually Costs

A line of credit charges interest on what you draw, plus often a fee on the undrawn portion, and you keep full control over collecting from your own customers. Factoring works differently: you sell an invoice, or a batch of them, to a factor at a discount, and the factor either collects directly from your customer or you continue collecting but pay a fee tied to how long the invoice stays outstanding. The discount rate on factoring is usually higher than the interest rate on a line, but it's compensating the factor for taking on collection risk you'd otherwise carry yourself.

A line of credit requires someone internally to manage borrowing base reporting, covenant compliance, and collections on your own receivables ledger. Factoring shifts a meaningful chunk of that collections workload to the factor, particularly in a non-recourse arrangement where the factor also absorbs the credit risk if the customer doesn't pay. If your finance team is thin and collections has been slipping, that shift in workload is often worth more than the rate difference alone.

The flip side is that factoring adds its own administrative overhead: submitting invoices for approval, reconciling factor statements, and managing customer confusion the first time they're asked to pay a third party instead of you.

In notification factoring, your customer is told to remit payment directly to the factor, which some customers read as a signal that you're short on cash, fairly or not. Non-notification arrangements exist specifically to avoid this, keeping your company as the point of contact while the factor is paid behind the scenes, though they tend to cost more and aren't available from every factor. If you sell to a small number of large, sensitive customers, this reputational angle should weigh as heavily in your decision as the discount rate does.

A line of credit's borrowing base typically caps how much any single customer's receivables can count toward your availability, which penalizes concentrated customer bases directly. Factoring can sometimes go the other way: a factor may actually prefer a smaller number of large, creditworthy customers, since their own underwriting is essentially a bet on whether those specific customers pay. If your top two or three customers carry strong credit, factoring against just those invoices while leaving the rest on a line can outperform either option used alone.

Price both options against the same batch of invoices for a full quarter rather than comparing headline rates in the abstract. Track the all-in cost of the line, including the unused fee and any covenant compliance time, against the all-in cost of factoring, including the discount and the administrative overhead of managing the factor relationship. Whichever one comes out ahead on real invoices, over a real quarter, is a far better answer than whichever one had the lower advertised rate.

Run the comparison with these steps:

1. Price both options against the same batch of invoices for a full quarter instead of comparing headline rates in the abstract.
2. For the line of credit, total the interest, the fee on the undrawn portion and the staff time spent on covenant compliance.
3. For factoring, total the discount plus the administrative overhead of managing the factor relationship.
4. Compare the two all-in figures side by side, and consider a blend, such as spot factoring against one slow-paying customer.

Few companies actually need to pick exactly one and abandon the other permanently. A common pattern is running a line of credit as the default, lower-cost source for day-to-day working capital, and turning to spot factoring only against a specific slow-paying customer or a one-time gap that would otherwise strain the line's borrowing base. This keeps the cheaper option as your baseline while still giving you a release valve for the exact situations where factoring's speed and risk transfer are worth the extra cost.

Revisit the split periodically rather than treating whatever you set up first as permanent. As your receivables aging improves or your customer concentration shifts, the balance that made sense a year ago may no longer be the cheapest way to fund the business today.