What is Accounts Receivable Financing?

Accounts receivable financing, commonly known as factoring or invoice financing, entails the selling of receivable or outstanding invoices at a markdown to obtain cash for company operations. Having cash flow coming into your business is critical to keep operations running but if you have customers with unpaid invoices or slow-paying invoices, accounts receivable financing will get you the cash flow you need quickly and efficiently.

Small business owners find traditional business financing difficult to qualify for since they have a long list of requirements that small business owners might not meet at the point of needing the funds. Often, business owners will consider accounts receivable financing because it is easier to qualify for than bank or credit loans. Selling unpaid invoices is a way for a business to get cash fast without collateral. When filing for a traditional bank loan, a business is required to use collateral and put the company’s assets at risk if the business cannot repay it.

How Does It Work?

Accounts receivable financing is a great option for companies that have creditworthy clients. The type of businesses that qualify for this type of financing are startups, minority-owned businesses, and businesses that face challenging funding situations.

There are three types of receivables finance:

1. Asset-based lending (ABL): this is also commonly known as a business line of credit or traditional commercial lending. With asset-based lending, companies commit their receivables and have limited flexibility about which ones are committed.
2. Traditional factoring: with factoring, the lender takes over the collection of each purchased receivables.
3. Selective receivables finance: this allows companies to pick and choose which receivable to advance for payment. The rates are typically lower than the two other alternatives. Companies favor selective receivable finance the most because of the flexibility of participating when they need to, and they can choose which receivables are paid early.

The following are what the steps look like for someone who wants to apply for accounts receivable financing:

1. Apply for financing – after finding the right lender you want to work with, you begin by filling out their application which requires some basic information about yourself and your business.
2. Submit your invoices – the lender then will require you to submit your invoices in order to determine if the quantity and quality of your invoices are enough to qualify for financing.
3. Approval decision – the next step is the lender needs to make an approval decision. The lender will assign a line of credit based on what your invoices looked like. This decision usually is given within the same day or it can take up to several days as well.
4. Use your line of credit – the funds will be transferred to you immediately if the lender approves your application. They should be in your account within one to two business days and will be ready for use.
5. Collect payments & repay lender – payments will still be collected as normal from your customers and as you collect them you will repay any funds you’ve taken from your line of credit.

Pros and Cons of Accounts Receivable Financing

Pros

• Fast cash: when your business has a shortage of cash flow, the funds are needed as quickly as possible and with accounts receivable financing you will have the cash flow needed to support your business within a day.
• Collateral is not needed: there are no assets or guarantors required as collateral with this type of financing unlike traditional bank loans. In this case, the invoices themselves act as collateral.
• 100% ownership of your business: you will not be required to give part of your business up to acquire the funds. You retain 100% control of your business because there are no other investors involved.

Cons

• Expensive costs: although the process is quick and easy, it could possibly come at higher costs than other business loans.
• Lengthy contracts: some contracts can be short others can be lengthy so it’s important to negotiate with the lender and see what is best for you and your business.
• Additional fees: based on the lender you choose, you may be responsible for the following fees: servicing, application, set up, withdrawal, and processing fees.

How To Choose the Right Lender for Your Business

After you’ve informed yourself of how accounts receivable financing works, the pros and cons, and you want to move forward with then the next step is find the right lender for your business.

You must first understand and meet all the requirements. Each lender is different, one may have a specific set of requirements and another one may have a strict set of requirements. If the lender requires a minimum credit score, it is your responsibility to know your score and see if you are a good fit. Also, be sure to look at all the costs when borrowing the funds. Be sure to add in any additional fees to the total cost of borrowing and see if it is affordable for you or not.

Accounts receivable financing is best if you have a lot of unpaid invoices and don’t qualify for any other loans. Be sure to evaluate the needs of your business and financial situation to see if this financing option is right for you.