About Accounts Receivable Financing
Accounts Receivable Financing, sometimes referred to as factoring, allows businesses to literally cash in on unpaid receivables. There are a couple different ways this type of financing can be structured. Either a lender will “buy” unpaid invoices directly or the business will “pledge” the invoices to the lender and remit funds when the invoices are paid.
Typically a lender will advance the business a percentage of the unpaid invoice up front (typically 70-85%). When the invoice is paid the business and the lender will settle up the balance depending on how the loan was structured. While factoring companies are not collections agencies, some business owners enjoy the freedom to focus on the next project and allow the AR company to collect payment from the client directly.
An example of when Accounts Receivable Financing might be great option:
An emerging government contractor has just been awarded a $500,000 contract that he has been trying to win for months. After a quick celebratory dance, the panic sets in… How will he get more cash to staff the project and purchase the supplies needed? We all know the government can move at the speed of molasses and the quick online loans used in the past would eat into the profit margins too much. Cue lightbulb: with the newly obtained contract in hand, the business owner already has the collateral he needs to obtain funds using Accounts Receivable Financing.
Once the process is complete, the business receives 70% of the contract immediately to move forward with staffing for the new contract – crisis averted! Months down the road when the contracted project is complete the government will issue payment to the lender directly. The AR company will withhold what is due to them per the financing agreement and forward the balance to the business owner. Accounts Receivable Financing enabled the business to financially support a project they would not see revenue from for several months.
Credit Reports – Much of the rating for accounts receivable financing comes from the credibility of the businesses clients. Often accounts receivable financing will not show up as a new trade line on personal credit reports keeping the business owners bureau scores from taking a hit. In cases where the invoices being advanced on are with “investment grade” entities (i.e. invoices directly to the federal government or large public entities) the lender may even waive the need for a personal guaranty.
Flexibility – This type of financing allows the the business owner to spend the funds where they are needed from covering payroll to purchasing inventory.
Speed – Accounts Receivable Financing can have money in your account in as little as 48 hours.
Control – Some lenders will want to work directly with your clients to receive payment, which can be uncomfortable for some business owners. Other lenders simply require you to list their banking information as the “remit to” section of your invoice to your client.
Cost – Accounts Receivable financing is not the most expensive “working capital” option out there, but there are fees. Be sure to read the fine print as some lenders charge monthly fees to be in their accounts receivable program that are separate from the fees associated with an actual advance.
Dependency – In some industries, Accounts Receivable Financing is used on nearly all contracts and the costs are accepted as part of the deal.
Most lenders require that invoices being advanced are expected to be paid in 30-60 days, meaning if you have a client with a history of slow paying it is unlikely a lender will advance funds (lenders don’t want to become debt collectors). The exact requirements will vary depending upon the type of invoices being advanced on, industry and time in business.