What Is Accounts Receivable Financing?
Let me explain accounts receivable financing directly to you: it's a financing setup where your company gets capital based on a portion of its accounts receivable. These agreements can be set up in various ways, typically as either an asset sale or a loan.
Understanding Accounts Receivable Financing
I'm going to break this down for you. Accounts receivable financing involves capital tied to your company's accounts receivable, which are the outstanding balances from invoices you've billed to customers but haven't collected yet. You report these on your balance sheet as assets, usually current ones since payment is due within a year.
Accounts receivable factor into your company's quick ratio, which looks at your most liquid assets like this: Quick Ratio = (Cash Equivalents + Marketable Securities + Accounts Receivable Due within One Year) / Current Liabilities. This makes them highly liquid in theory, valuable to lenders and financiers.
But you might see accounts receivable as a hassle because they're expected payments that need collection and can't be turned into cash right away. That's why accounts receivable financing is growing fast to address these liquidity challenges, with external financiers stepping in to help.
You often hear this process called factoring, and the companies specializing in it are factoring companies. The best ones focus heavily on accounts receivable financing, though any financier might offer factoring. They can structure these deals in different ways with various provisions to suit your needs.
Key Takeaways
- Accounts receivable financing gives you capital related to a portion of your company's accounts receivable.
- These deals are usually set up as asset sales or loans.
- Many financing companies connect directly to your accounts receivable records for quick and simple capital access.
Structuring
Accounts receivable financing is getting more common thanks to new technologies that link your business's accounts receivable records to financing platforms. In my experience, it's often easier for you to get this kind of financing than other capital options, especially if you're a small business that meets the criteria or a large one that can integrate tech solutions easily.
There are a few main ways to structure these deals, and I'll cover them next.
Asset Sales
Typically, you structure accounts receivable financing as an asset sale, where your company sells the receivables to a financier. This is similar to how banks sell off loan portions.
You get capital as cash, replacing the accounts receivable value on your balance sheet. You might need to write off any unfinanced balances, depending on the principal-to-value ratio in the deal.
A financier could pay up to 90% of the outstanding invoices' value, often by linking to your records. Most factoring platforms work with systems like QuickBooks, letting you sell individual invoices as they're booked for immediate capital.
In these sales, the financier takes over the invoices and handles collections. Sometimes, they even rebate cash if invoices are fully collected.
Factoring companies usually avoid buying defaulted receivables, preferring short-term ones. Selling transfers the default risk to them, which they work to minimize.
They profit from the spread between principal and value, plus fees that boost their returns.
Take BlueVine, a top player in this space—they offer options like asset sales, connecting to software such as QuickBooks, Xero, and FreshBooks. They pay about 90% upfront and the rest minus fees once the invoice is paid.
Loans
You can also structure this as a loan, where various terms depend on the financier. The key advantage is you don't sell the receivables; you just get an advance based on them. These loans might be unsecured or secured by invoices, but you have to repay them.
Companies like Fundbox provide loans or lines of credit based on your receivables, advancing up to 100% if approved. You repay over time, with interest and fees.
These lenders gain from linking to your systems like QuickBooks, Xero, and FreshBooks, enabling instant advances on invoices or overall credit line management.
Underwriting
When deciding to bring you on board, factoring companies consider several factors. The deal terms and amount offered relative to your receivables will vary.
Invoices from large corporations are often more valuable than those from small businesses or individuals. Newer invoices are preferred over older ones. The age of receivables heavily affects terms—shorter-term ones get better deals, while longer-term or delinquent ones might mean lower amounts and ratios.
Advantages and Disadvantages
This financing lets you access cash instantly without the hurdles or delays of traditional business loans. If you go with asset sales, you skip repayment worries and collections.
With a loan, you might get 100% of the value right away. But accounts receivable financing can have a negative stigma and cost more than traditional options, especially if your credit is seen as poor.
You could lose money on the spread in asset sales, and with loans, interest might exceed what you'd lose on discounts or write-offs.
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