A line of credit is a revolving loan. The lender approves a maximum amount, and the business can draw, repay and redraw as needed, paying interest only on the outstanding balance.
How it works in factoring
Lines of credit and factoring both address short-term cash needs, but they work differently:
| Line of credit | Factoring | |
|---|---|---|
| What it is | A loan | A sale of invoices |
| Approval depends on | The borrower's credit and financials | Largely the customers' credit |
| Size | Fixed limit | Grows with sales |
| On the balance sheet | Debt | Often not debt, depending on structure |
| Covenants | Common | Fewer, but more invoice-level controls |
A bank line is often less expensive than factoring for a business that qualifies. However, banks typically want a track record, profitability, collateral and personal guarantees. Newer, fast-growing or thinly capitalized businesses may not qualify, or may get a limit too small for their growth.
Some businesses use both. That requires care, because the bank's line is often secured by a lien on all receivables. Selling receivables to a factor without the bank's consent can breach the loan agreement. An intercreditor agreement can carve out specific customers or receivables for the factor.
What to check
- Whether the line is secured, and by what
- Annual renewal requirements and fees
- Covenants that could cause the bank to freeze the line
- Whether your loan agreement allows any sale of receivables
Factoring and lines of credit are not competing in every case; the right choice depends on qualification, cost and how quickly sales are growing.