What Is Accounts Receivable Financing?
Accounts receivable financing (AR financing) is a quick way to access capital when you can’t afford to wait the 30-90 days that your customers take to pay for the goods or services they have received. AR financing is a loan or cash advance that’s secured by your unpaid invoices.
Three Types Of Accounts Receivable Financing
- Traditional Factoring: With traditional factoring, you sell your accounts receivables to a third party. The funder takes over ownership of the invoice and the customer pays directly to the lender. You still receive financing quickly, but the total is less than other types of accounts receivables financing. You might receive only 85% of the invoice amount, minus fees. The remaining 15% is received once the customer has paid the lender. Once you choose a customer for traditional factoring, all outstanding invoices must be sold to the factoring company
- Asset-Based Lending: Asset-based lending is more like a collateralized loan. Accounts receivables can be used as collateral in asset-based lending. The loan is based on liquidity value. Asset-based loans are easier to obtain than lines of credit and unsecured loans and usually, come with more favorable interest rates. Unlike traditional factoring, you aren’t selling your accounts receivables, merely using them to leverage the loan
- Selective Receivables: With selective receivables financing, you have control over which unpaid invoices you send to the AR financing company. Your advance is based on the full amount of each receivable. Selective receivables don’t show up on the balance sheet, protecting your debt-to-income ratio
Why Is Selective Receivables Finance A Preferred Option?
- Flexibility: You have the flexibility to choose which receivables to submit for AR financing, rather than needing to turn over the entire book of receivables. This protects your ability to give allowances to certain customers. Additionally, because you select which receivables to submit, you can work with more than one AR financing company, reducing the risk of relying on a single institution
- Better Pricing: The fact that you can submit your receivables to more than one financing company sets up a competitive pricing scenario that benefits your business
- On Demand. You use it only when you need to, which is perfect for covering downturns due to economic volatility or seasonal demand
- No Impact On Your Credit: Selective receivables financing isn’t counted as debt. There is no negative impact on your credit history or ability to apply for lines of credit or loans in the future
How Does Accounts Receivable Financing Work?
Accounts receivable financing is based on your unpaid invoices, your credit history is less important. You receive an advance equal to the sum you are owed. Your invoices serve as collateral and therefore you aren’t required to provide additional security. AR financing companies charge a fee from 1% to 5% of the invoice amount. Once the invoice is paid, the accounts receivable company sends you the balance, minus fees.
Consider this example.
You just completed a major sale worth $500,000. You shipped the product to the customer, along with the invoice for payment. The customer says that he can pay you in four months. You need the money sooner to cover operating costs.
You apply to an AR financing company. The company advances you 80% of the total receivable, or $400,000, which you receive within 1-2 days. The remaining 20% is kept as security until the receivable is collected. In this scenario, you still have control over the invoice and contact with the customer. Once the total amount is collected, the AR financing company forwards the 20% that was held, minus a financing fee.
Why Does it Matter?
- Statistics say that almost 60% of invoices aren’t paid on time. This limits the amount of working capital available to cover your operating expenses. The resultant cash flow gap means that you aren’t able to capitalize on business opportunities or reinvest in your business
- Quick access to cash is especially critical when facing seasonal demands and no cash reserves to cover them. Accounts receivable financing enables you to purchase seasonal inventory or hire temporary employees so you don’t lose ground to competitors
- Perhaps you have routine expenses that need to be paid. The cash flow gap caused by unpaid invoices causes you to miss payments, hurting your credit. AR financing can protect your credit and reputation with vendors
- The accounts receivable financing process is easy and quick, and you receive the money right away. No additional collateral is needed since the advance is based on accounts receivable
Receivable financing is a quick and convenient way to cover cash flow gaps due to outstanding invoices. Selective receivables financing affords the most flexibility, saves money, and protects your credit score. Best of all, accounts receivable financing ensures time-sensitive expenditures and expansion doesn’t need to be put on hold.