How Accounts Receivable Financing Works

What is Accounts Receivable Financing?

Accounts receivable financing provides businesses with a flexible, accessible, and efficient way to manage their cash flow and access working capital. This financial solution specifically tackles the obstacles posed by lengthy payment cycles, late payments, and gaps in cash flow. As a result, businesses can maintain stability, capitalize on growth opportunities, and thrive in competitive markets.

How Does Accounts Receivable Financing Work?

Factoring companies typically look at several criteria to determine if an applicant qualifies for accounts receivable financing. These may include the payment history of customers, the credit history of the applicant, and corporate tax information. Based on this information, the factoring company determines whether an invoice or set of invoices is suitable for collateral. If cases where an invocie poses a high risk, the lender may choose to decline it as collateral for financing.

Here’s a quick breakdown of how AR financing works:

  1. The business owner sells a service or product to a customer, allowing the customer to pay at a later date—often 30, 60 or 90 days later.
  2. The business owner uses this customer’s invoice as collateral to secure a cash advance from a factoring company.
  3. The factoring company advances issues a cash advance — typically between 80% and 95% of the invoice — to the business owner.
  4. The factoring company collects payment from the business’s customer.
  5. The factoring company pays the business owner the remaining difference of the invoice minus a fee.

RELATED: How Much Are Your Accounts Receivable Costing You?

How Can Accounts Receivable Financing Help Fund Your Business?

When it comes to getting the cash your business needs to cover your day-to-day expenses, expand your operations or cover a large order, there are several options. Receivables factoring offers numerous advantages in such situations, including its speed, doesn’t require a lengthy application and underwriting process, and flexibility. By selling its accounts receivable, businesses can access funds quickly, typically within days rather than weeks, without incurring repayment obligations. This allows future cash flows to remain intact.

Financing receivables proves beneficial for businesses of various industries. It enables them to obtain immedate cash without the need to qualify for a loan and eliminates the burden of future payments. Additionally, financing receivables enables businesses to transfer liabilities from their balance sheet, leading to an improved financial position for the ocmpany.

Receivables factoring allows businesses to offer payment terms to customers that may extend past the usual 10-day period while still receiving immediate payment. The sale of accounts receivable does not create any debt and requires no repayment.

What Are The Benefits of AR Financing?

Selling accounts receivable offers a swift solution to maintain a healthy cash flow, even when businesses provide extended payment terms to their customers. When a company grants credit terms, they agree to deliver goods or services upfront, with payment scheduled for a future date. In return for deferring payment, the company receives interest, acting as a premium, from the customer at a later time. This arrangement allows businesses to remain competitive by offering customers the convenience of paying for purchases over time.

However, there are instances when customers encounter difficulties in making timely payments, which hinders the company from accessing the funds generated by the sale. This situation poses financial challenges as the company is unable to utilize the cash to produce additional goods and services. To overcome this predicament and maintain a favorable financial position, businesses can opt to sell their accounts receivable.

Key Benefits of AR Financing:
  1. Improved Cash Flow: One of the primary benefits of AR financing is improved cash flow. Rather than waiting for customers to pay their invoices, businesses can access immediate cash by selling their outstanding invoices to a financing provider. This influx of cash helps businesses cover their expenses, meet financial obligations, and seize growth opportunities without being constrained by long payment cycles.
  2. Faster Access to Funds: Accounts receivable financing provides businesses with quick access to funds. Once the financing provider approves the invoices, they can provide an advance payment within a short period, typically within 24 to 48 hours. This rapid funding allows businesses to address immediate cash needs and bridge the gap between invoicing and payment collection.
  3. Reduction in Bad Debt Risk: When a business extends credit to its customers, there is always a risk of non-payment or bad debt. With accounts receivable financing, the financing provider assumes the credit risk. They assess the creditworthiness of the business’s customers and take responsibility for collecting payments. This reduces the risk of non-payment and provides businesses with added protection against potential bad debts
  4. Enhanced Working Capital: By converting accounts receivable into immediate cash, accounts receivable financing boosts a business’s working capital. Working capital is vital for day-to-day operations, purchasing inventory, meeting payroll, and investing in growth initiatives. With increased working capital, businesses have the financial resources to operate smoothly and take advantage of new opportunities.
  5. Flexibility and Scalability: AR financing offers businesses flexibility and scalability. Unlike traditional bank loans that have fixed borrowing limits, accounts receivable financing allows businesses to access funding based on their sales and the value of their outstanding invoices. As the business grows and generates more invoices, the financing can scale accordingly, providing a reliable and adaptable source of working capital.
  6. Focus on Core Operations: Managing accounts receivable, chasing payments, and handling collections can be time-consuming and distract businesses from their core operations. With accounts receivable financing, the financing provider takes over the responsibility of collecting payments, allowing businesses to focus on their core activities such as sales, customer service, and product development. This enables businesses to operate more efficiently and effectively.
  7. No New Debt or Impact on Credit Rating: Accounts receivable financing is not a loan, so it doesn’t create new debt for the business. Instead, it leverages the value of the existing accounts receivable. As a result, it doesn’t impact the business’s credit rating or debt-to-income ratio. This can be advantageous for businesses that may have difficulty accessing traditional financing due to a lack of credit history or lower credit scores.

Why do Companies Sell Their Accounts Receivable?

Growing a business and meeting daily operational expenses requires cash on hand, but for many companies maintaining the right cash flow is difficult when your customers want credit terms such as net 30, 45, 60, or even 90+ days for payment. Allowing customers the ability to extend their payment for up to three months can increase your ability to make larger sales and take on bigger clients, but it can also put a dent in the availability of working capital while waiting for payment. Many customers that get credit terms will wait until the last minute to make the payment in an effort to optimize their own cash flow situation.

The main reason that companies choose to sell their accounts receivable is simple: to reduce the amount of time between the sale of goods or services and compensation. This means you can now take on new orders without waiting for payments to come through, or invest in a strategy to grow your company.

Sometimes money can be tight for your business and it’s not necessarily because you are bad at managing your cash flow. For many companies it is the result of several elements such as:

  • Long payment cycles from the original sale of goods or services to eventual receipt of cash
  • Slow-paying or non-paying customers
  • Unexpected operational expenses that significantly reduce available cash
  • The need to purchase raw materials or inventory to meet orders and sales

Businesses can efficiently and promptly access the funds owed to them by selling their accounts receivables to an invoice factoring company, eliminating the need to pursue customers for payment. This approach proves especially beneficial for small to mid-sized businesses that may lack a dedicated collections department. A reputable factoring company typically offers collection services at no additional cost, ensuring a hassle-free experience for the business. Through invoice factoring, businesses can rapidly obtain the cash they are owed while entrusting the collection process to experts in the field.

RELATED: 8 Rules for Managing Your Accounts Receivable

How Much Does AR Financing Cost?

The fees associated with accounts receivable financing can vary among different factoring companies. Typically, lenders charge a fixed-percentage interest fee, such as 1% per week. However, it’s important to note that rates may differ based on the lender. However, it’s important to note that rates may differ based on the lender. For instance, Universal Funding’s rates offers rates starting as low as 0.55% per month, not on a weekly basis.

It’s essential to understand that the fees for accounts receivable financing using this structure can fluctuate depending on factors such as the age of the invoice and the creditworthiness of the client. If an invoice remains unpaid for an extended period, the total fee amount increases. Therefore, business owners should exercise caution when selecting invoices to be used as collateral for this funding option.

What is an Accounts Receivable Factoring Company?

Did you know that you can entrust the management of your accounts receivable to an accounts receivable factoring company? These financial institutions specialize in purchasing your invoices, providing your company with an immediate cash advance, allowing you to regain focus on generating more business. Accounts receivable factoring companies are also known as asset-based financiers, and partnering with them can be a crucial factor in driving your business’s growth.

By utilizing this rapid funding option, you can maintain a healthy cash flow, especially when dealing with slow-paying customers or those with extended payment terms. Accounts receivable factoring companies offer cash upfront, enabling you to shift your attention towards pursuing new business opportunities, rather than getting bogged down in manually processing invoices for products or services that have already been sold. Typically, traditional accounts receivable processing can take weeks or even months. Collaborating with the right factoring company can serve as the catalyst for your company’s future growth.

RELATED: 10 Considerations When Selecting the Best Factoring Company for Your Business

What is Accounts Receivable Insurance?

Accounts receivable insurance offers protection against financial losses to its accounts receivable. When a company is unable to collect from its customer that owe the business money, AR insurance protects against these losses.

Universal Funding provides accounts receivable insurance which helps protect clients from unforeseen and unexpected potential losses due to their customers’ inability to pay. Accounts receivable insurance is a form of credit insurance offered by commercial insurers to businesses and can take the form of multi-buyer insurance (a pool of receivables) or key buyer insurance.

At Universal Funding, we assess the risk of your customers’ credit and payment cycles to determine a recommendation for accounts receivable insurance. This assessment is one of the added services we provide to all of our clients. If the assessment proves that your accounts would benefit having additional AR insurance, we work with a third-party vendor to provide those services.

Protect Your Profits With Accounts Receivable Insurance

Accounts receivable insurance offers protection from non-paying customers who have become delinquent in paying your invoices. It is very useful for a business that is growing rapidly and does not have the resources to do regular credit checks on new and existing clients. By partnering with a factoring company like Universal Funding who offers this added benefit, your company can get accounts receivable insurance that will protect you against lost receivables. This includes receivables from companies that have defaulted, claimed bankruptcy, or failed to pay within the allotted terms. The insurance protects your company in the event you are unable to collect money from the client and helps to provide the much-needed protection you need to manage your business profitably.

Learn how accounts receivable factoring can help you get quick access to working capital.