What Is Accounts Receivable Financing?

What exactly is accounts receivable financing? This type of commercial lending is a form of financing where you will receive a sum of money from a lender based upon a percentage of your accounts receivable. There are a few different ways that this can be structured, with the most common being either an asset sale or loan. Below we will look at both of these types of accounts receivable financing in more detail.

A problem that many small business owners face concerns invoice delays. You, of course, depend on money coming in to help you meet your financial obligations. When payments don’t come in promptly or when customers fail to pay period, then this could very well put you behind. Next thing you know, you find yourself scrambling to come up with the money that you need to meet your monthly bills.

With accounts receivable financing, you have the opportunity to get a loan based upon the amount of money that is owed —you could sell those outstanding invoices to a lending company and procure money in that way. Some refer to accounts receivable financing as factoring. And consequently, those who purchase the outstanding invoices are sometimes known as factors or factoring companies.

Different Structures of Accounts Receivable Financing

As mentioned, among the most common forms of accounts receivable financing are either loans based upon the value of invoices or the sale of invoices to a lender or factoring company.

Sale of Invoices

Very often, accounts receivable financing will be structured as a type of asset sale. With this agreement, the company needing additional working capital will sell its outstanding invoices to a lending institution or factoring company. The business in turn receives money in exchange for this particular asset. Keep in mind, the business will not receive 100% of the amount of unpaid invoices sold as the factor will charge a fee. Though, the amount paid out could be as high as 90%.

One of the benefits here, beyond of course receiving much-needed cash, is that the company or lender who purchases the accounts receivable will take responsibility for collecting on those invoices. This takes that task off the plate of the small business that sold the unpaid invoices.

Loans

In some instances, accounts receivable financing will be structured as a type of loan. This then means that the company does not sell their invoices, but they still receive funding based upon the value of those invoices. It then falls on the small business to collect on these outstanding invoices and thus pay the loan back. Keep in mind, there are interest and fees attached just as with the sale of accounts receivable.

Pros and Cons of Accounts Receivable Financing

Among the primary benefits of this type of financing is the fact that you can get the money you need sooner rather than later. In other words, you are not having to wait on a client to come through with their payment before getting the infusion of money you need. The lending company/factor gets that to you in advance of you finally being able to collect on an invoice.

Also, because the money loaned/paid out is based upon tangible accounts receivable it works a bit different than a traditional business loan. There is less wait time associated and also generally less paperwork. The invoices themselves also become the security on the loan, so it may be easier to qualify for than some other loan types.

Keep in mind too, that when selling your invoices, you no longer have to worry about collecting on those accounts; that should save you a good amount of time (and hassle) in the long run.

As with any loan type, there can be some disadvantages to going the accounts receivable financing route. For example, the interest and fees charged could be somewhat steeper than with more traditional kinds of business loans. And of course, you are giving up a portion of the money that you would otherwise be owed in full if collecting on the invoice on your own.

There is also the question of what this can potentially do for your relationships with customers. A factoring company, for example, may not be as cordial or patient with a nonpaying customer. Sometimes their tactics could be a bit more abrasive than how you might approach that client. There is a chance this could anger the customer and thus make it so that they don’t buy from you again. That said, if they are a customer who is habitually late in paying, then perhaps it is better to cut ties with them anyway.

First Union is Here for You

If you need additional working capital, we can certainly help. We offer accounts receivable financing options, along with a number of other fast and flexible business loan programs. From Miami Beach to Dallas, Texas, we cultivate long-term relationships with our small business clients. Call today!

Published in Business Finance

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