Accounts Receivable Financing
For many businesses, a line of credit can be established by leveraging the accounts receivables. Accounts receivable factoring (sometimes called accounts receivable financing, invoice factoring, invoicing discounting, or ledgered line of credit) can be an effective financial tool to manage day-to-day cash needs and support growth. Accounts receivable factoring could be an ideal financing option if your company:
- Requires immediate cash or a credit line that will provide a continuous source of cash flow;
- Does not want restricted traditional bank financing;
- Does not want to add debt to its balance sheet.
- Wants more flexibility and control of its cash flow
- Prefers a manageable, easy-to-use financing option that can grow with its business;
- Has significant cash tied up in accounts receivables;
- Has seasonal or erratic cash flow needs;
How Accounts Receivable Factoring Works
While there are many advantages to accounts receivable factoring, two of the most important for a business are the simplicity of the process and the speed with which it can be implemented. Here's how accounts receivable factoring works:
- Your company sells an unpaid eligible receivable to an accounts receivable factoring company. Eligibility is based on your customer's creditworthiness (not your company's).
- Your company receives an initial payment, usually up to 90% of the face amount of the receivable, within 24-48 hours.
- When the receivable is paid in full, your company receives the balance due, less a small fee.
An accounts receivable factoring plan can be structured to suit your company's individual needs, including:
- Low financing costs and fees
- No monthly borrowing minimums
- No need to provide company financial reports
- No financial audits
- Quick decision-making and initial setup
- 24-hour funding once a plan is in place
- Preferred credit lines of $1,000,000 to $10,000,000
While simplicity and speed are two advantages of accounts receivable factoring for companies, they aren't the only reasons to consider this funding option. There are many more reasons to consider this strategy to increase your company's liquidity.
Advantages of Accounts Receivable Factoring
For such a simple process, the potential benefits to your company of using accounts receivable factoring are significant:
- Simplicity - Easy to Set Up and Use. As long as your company has accounts receivable with creditworthy companies, it should be able to qualify for accounts receivable financing. With most companies, setting up an accounts receivable financing program takes only days.
- Limited Administrative Requirements. Ongoing administrative requirements for your company's accounts receivable factoring program are limited. Once you invoice an eligible customer for goods or services, you simply remit copies of the invoice and related documentation and the factoring agent will take over the collection process and make your cash available.
- Convenient Structure. The typical accounts receivable factoring structure is a line of credit backed by the eligible accounts receivables that you choose to sell.
- Fast Cash. Accounts receivable factoring allows your company to raise cash almost immediately rather than waiting up to 60 days for customers to pay. Usually 80% or more of the face value of a receivable is available within 24-48 hours, with the balance (less a financing fee) received when the receivable is paid (based on its payment terms).
- Flexibility and Control. You decide which receivables to sell and when and, therefore, have substantial flexibility to control your company's flow of cash.
- Growing Cash Availability. As your business grows and its accounts receivable balance increases, the amount of cash available from selling receivables will grow as well.
- Continuous Cash Availability. As long as your company has eligible accounts receivable to sell, you will be able to obtain cash without time-consuming paperwork or administrative hassles.
- Not Debt. Cash received from accounts receivable financing is not a loan. Therefore, it does not negatively affect your company's credit rating or leverage its balance sheet.
- Free Up Working Capital. If you company has a substantial amount of capital tied up in accounts receivable, accounts receivable factoring allows you to free up some of that cash for current needs.
- Flexible Use of Proceeds. How your company uses the proceeds from accounts receivable financing is up to you. It can be used for any of the numerous cash needs of a growing business, including making payroll, buying equipment, purchasing inventory, paying taxes, repaying debt, bidding on new business, or taking advantage of supplier discounts.
- Lower Costs, More Time. When you sell an accounts receivable you also outsource its collection to professionals. This process can help to reduce the time and manpower your company devotes to the often time-consuming collections process.
- Not Based on Your Company's Creditworthiness. Your accounts receivable factoring line is based on the creditworthiness of your customers not your business. As a result, it can be a solid funding source for your company.
- A Credit Building Option. Accounts receivable factoring can be a great way for your company to enhance or repair its credit rating by allowing it to grow its assets, strengthen its balance sheet, and reinvest in its business without taking on debt. Stronger credit can result in access to additional financing options, including traditional bank loans.
- Available Broadly. Accounts receivable factoring is a financing option that works for companies in a broad range of sectors and industries. It also works for both private and public companies. Whether your company operates in the service sector or is a manufacturer or distributor, it may be able to benefit from factoring.
Frequently Asked Questions
Here are answers to some of the most frequently asked questions about accounts receivable factoring. For more information, please contact us at 888-525-8735.
Who can qualify for accounts receivable factoring?
Any company with a roster of high-quality customers may qualify to raise cash through accounts receivable factoring, including:
- Both private and public companies and companies that are closely held
- Companies that prefer an alternative to commercial bank financing
- Fast-growing companies with the need for immediate cash to fund their expansion
- Companies in seasonal businesses that face temporary spikes in cash requirements or a mismatch between costs and revenue
- Companies that want to take advantage of short-term business opportunities such as vendor discounts and volume purchases
- Companies with large accounts receivable balances
- Companies for whom accounts receivable collections is a time-consuming chore that diverts management's attention from growing the business
- Companies that are recovering from financial difficulties
How does accounts receivable factoring compare to borrowing from a bank?
The difference between accounts receivable factoring and a bank loan are significant, although both can generate needed capital for your business.
Most importantly, cash generated by accounts receivable factoring is not a loan, does not add debt to your company's balance sheet, and is not based on your company's creditworthiness or its financial position. Instead, it is based on the creditworthiness of your company's customers.
Another important distinction between accounts receivable factoring and bank lending is the speed of decision making. Typically, a decision on an accounts receivable program can be made in a week, whereas it may take weeks or even months to obtain a bank loan.
Finally, factoring does not involve the covenants and restrictions that are often included in a bank loan agreement, and it does not require collateral.
How does accounts receivable factoring compare to other types of business financing, such as private equity or nonbank financing?
While other types of financing have to be evaluated individually, in some instances, such as with private equity, they may require you to give up a share of your company or to cede some control to others. This is not a consideration with accounts receivable factoring.
What information is required for accounts receivable factoring?
Usually you will only need to fill out a short application and to provide your company's business documentation, as well as information about its customers and receivables.
Do I need to provide audited financial statements or asset appraisals to start an accounts receivable factoring program?
No, since the program is based on the creditworthiness of your company's customers not of your company, you usually do not need to submit audited financial information for you company.
Can I choose which customers to include in my accounts receivable factoring program?
Yes, it is up to you which customers and what share of their receivables you want to submit for factoring. The accounts receivable factoring company will determine whether they qualify based on their creditworthiness.
You can choose to submit as little or as much of your accounts receivable portfolio as you would like. Also, the share that you submit can change over time based on your company's needs.
Another advantage of accounts receivable factoring is that, as your business and its eligible accounts receivable balances grow, the cash available to you from accounts receivable factoring will grow as well.