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With accounts receivable (AR) financing, you use your outstanding invoices to receive quick access to capital, either by selling those invoices or by using them as collateral to receive a loan.
Unlike many types of business loans, AR financing usually doesn’t require any kind of minimum credit score, revenue, or years in business. However, there are some tradeoffs involved. Here’s what you need to know about accounts receivable financing.
Key Points
• Accounts receivable (AR) financing gives a business access to quick capital based on the value of its accounts receivable.
• With AR financing, you can use your outstanding invoices as collateral for a loan or line of credit, or you can sell them to a third party.
• This type of financing can benefit businesses with cash flow gaps due to delayed customer payments, providing funds without the need to wait for receivables to clear.
• Different types of accounts receivable financing include asset-based lending, traditional factoring, and selective receivables finance — each with unique structures and implications.
• Approval for AR financing is based on the creditworthiness of clients rather than the business itself, which can make it easier to qualify for than traditional funding.
What Is Accounts Receivable Financing?
For businesses that issue invoices to clients, accounts receivable financing (also known as invoice financing) is a way to get an advance on the balances owed on those invoices, minus fees.
What Is Accounts Receivable?
Accounts receivable is a term that refers to money that your customers owe you. This differs from accounts payable, which refers to bills from vendors that you need to pay. Whether you use cash accounting or accrual accounting, accounts receivable is listed on the balance sheet as an asset, since it’s money that is owed to your company.
Accounts receivable financing is a type of small business financing that is based on the value of your accounts receivable. In some cases, AR financing involves selling those invoices at a discount. In other cases, you use the invoices as collateral for a loan or line of credit.
Essentially, AR financing allows you to use capital that would otherwise be unusable until your customers settle their invoices. Ideally, this can help you maintain an adequate or even comfortable business cash flow.
Recommended: Guide to Typical Small Business Loan Requirements
How Does AR Financing Work?
When you apply for a business loan, lenders typically want you to meet an array of criteria. You may have to have certain personal or business credit scores, years in business, and revenue levels, for example.
With AR financing, on the other hand, the lender approves the funding and loan amount by reviewing your clients’ payment histories, weighing their creditworthiness more heavily than your business credit score. As a result, this can be a good funding option for small businesses with a limited or poor credit history.
In general, the process looks like this: You apply for financing through an AR lender and submit your outstanding invoices. If approved, you’ll be advanced an amount, typically less than the full amount of the invoices. The advance may be structured as an asset sale (called factoring) or as an invoice-backed loan or line of credit. How it works from here will depend on the type of AR financing you choose.
Accounts Receivable Financing vs. Factoring
It can be helpful to see the characteristics of accounts receivable financing and factoring side by side. Below is a quick rundown of the two.
| Accounts Receivable Financing | Factoring |
|---|---|
| Your company retains the invoices | You sell the invoices to a factoring company |
| Is a loan that you have to repay | Gives you an advance payment to pay for the invoices you sell the factoring company |
| You are still responsible for collecting payment on the invoices from your clients | The factoring company collects payments for the invoices from your clients |
| Your customers will probably be unaware of the process | Your customers will interact with the factoring company |
| If the clients don’t pay, you still have to repay the lender | If the clients don’t pay, that won’t affect you |
Types of Receivables Finance
There are actually three different types of accounts receivable financing, and each works slightly differently. Here’s a closer look.
Asset-Based Lending (ABL)
With asset-based lending, you use an asset as collateral to receive financing. With asset-based invoice financing, you use your accounts receivable as collateral to get a loan or line of credit from an invoice financing company. You’ll pay interest on the amount you borrow and retain ownership of the invoices. However, you must repay the loan based on the agreed terms, regardless of whether your customers all pay their invoices in full.
Traditional Factoring
With invoice factoring, you sell your accounts receivable to a factoring company. The company will typically give you less than the invoice value (often 70% to 90%, though this can vary by industry) up front. They are then responsible for collecting on the invoices directly from your customers. Once your customers pay, the company will take out fees and forward you the balance.
One advantage of factoring is that you won’t have to chase down payments from your customers. However, factoring tends to cost more than asset-based invoice financing, since the factoring company does more work to collect payments. Also, keep in mind that having a third party interact with your clients could damage your business relationships.
Selective Receivables Finance
With traditional invoice financing, you typically upload all outstanding invoices and get an advance based on that number. With selective receivables financing, on the other hand, you can pick and choose which invoices you want to use for financing.
For example, maybe you know that one client, who has a $7,500 monthly retainer, pays a little late but is still reliable about paying. That might be the receivable you want to use for financing, since you’re confident the invoice will get paid.
Financing rates for selective receivables financing are typically lower than other types of invoice financing, due to the high quality of the receivables. In addition, this type of financing can sometimes be structured so it won’t show up on your company’s balance sheet — or impact your ability to qualify for other types of business financing.
Pros and Cons of Accounts Receivable Financing
Is accounts receivable financing a good option for your business? Here’s a look at the overall benefits and drawbacks of this type of funding.
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Pros:
• Provides quick access to funds
• Easier to qualify for than traditional business financing
• Improves cash flow
• With factoring, you don’t have to chase down client payments
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Cons:
• Costs more than many other small business financing products
• With factoring, your customers will be contacted by a third party
• With asset-based invoice financing, you’re depending on customer payments
• Limited to businesses with outstanding invoices
Pros
The process of securing invoice financing is typically faster than traditional loans. This speed can be critical for small businesses that need quick capital. It’s also generally easier to qualify for invoice financing, since approval is based on the creditworthiness of the clients who owe the invoices, rather than the credit history of the business itself.
Accounts receivable financing can also improve your company’s cash flow, allowing you to invest in improvements, pay suppliers, and promote business growth before customers pay balances fully. And in the case of factoring, it also allows you to completely wash your hands of the stress of getting clients to pay invoices.
Cons
On the downside, the cost of accounts receivable financing is typically higher compared to more traditional types of business financing, such as a term loan from a bank.
Additionally, if you go with AR factoring, you will lose control over communication with your clients. If you choose AR lending, on the other hand, you’ll still be on the hook for getting your clients to pay their invoices or you may have to pay your debt out of pocket.
This type of financing is also limited in scope, since it only applies to businesses with outstanding invoices. Companies with cash sales or advance payments may not be able to benefit from this financing model.
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How to Qualify for Accounts Receivable Financing
Typically, for accounts receivable finance, lenders are more interested in the payment history of the clients who owe money on the invoices, not the company applying. That said, they may want to see that the company has a reliable flow of B2B invoices, makes a minimum amount of yearly revenue (typically $1 million to $2 million) and has been in business for at least one to two years. The lender will likely also want to know that the clients have reliable payment histories and that the invoices don’t have any liens, disputes, or conditions attached to them.
Costs and Fees of AR Financing
Accounts receivable financing is typically more costly than many other kinds of small business financing. While AR financing doesn’t charge traditional interest, it does involve a financing fee.
With accounts receivable finance, after you receive an advance from the lender, you will be charged a financing fee linked to how long it takes your clients to pay their invoices (and you to pay the lender). For each week that the lender is waiting for payment, you’ll be charged a specific percentage of the invoice value – typically between 1.00% and 5.00%. In some cases, there might also be additional fees, such as origination fees or maintenance fees, so it’s important to be sure you understand the terms.
The Takeaway
Accounts receivable financing is a way for businesses to access cash by using their unpaid customer invoices as collateral for a loan or by selling them to a factoring company.
This type of financing could be useful if you experience cash flow gaps due to delayed customer payments, as it allows you to maintain steady operations without waiting for receivables to clear. But there are some downsides involved, including costs. Before you jump into AR financing, it’s a good idea to weigh the pros and cons and compare it to other funding options that may be available to your small business.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is the difference between factoring and accounts receivable financing?
Factoring and accounts receivable (AR) financing are both ways to access funds based on outstanding invoices, but they differ in structure. Factoring involves selling invoices to a third-party company at a discount; this company then collects directly from customers. In AR financing, the business retains ownership of the invoices and borrows against them, using the invoices as collateral. While factoring is typically faster and offloads collections, AR financing allows the business to maintain control over client payments and customer experience.
Is a loan considered accounts receivable financing?
A loan is different from accounts receivable financing. With a traditional loan, a business borrows a lump sum from a lender and repays it with interest over time, regardless of invoices. With accounts receivable financing, a business accesses funds by borrowing against their unpaid invoices, using them as collateral. The company must still repay the loan.
What is an example of an account receivable?
An account receivable is money owed to a business by a customer for goods or services provided but not yet paid for. For example, a consulting firm might complete a project for a client and issue an invoice for $3,000, giving the client 30 days to pay. Until the payment is received, this $3,000 invoice is considered an account receivable for the consulting firm. The receivable will appear as an asset on the firm’s balance sheet, since the customer is legally obligated to pay the debt and the company expects to collect it.
What are the eligibility requirements for accounts receivable financing?
Eligibility requirements for accounts receivable financing can vary by lender, but typically they involve assessing the creditworthiness of the clients who haven’t yet paid their invoices, rather than the qualifications of the business requesting the AR financing.
What types of businesses benefit most from accounts receivable financing?
Accounts receivable financing may work best for B2B businesses that have a reliable flow of invoices with clients they trust to pay them. Companies that need capital but that haven’t established a credit history yet or have a poor one may want to try AR financing.
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