Accounts Receivable Financing

Keeping cash flowing while operating a small business can be one of the biggest challenges business owners face, but there are some options for raising capital other than a traditional business loan that you may not know about or thought of like accounts receivable financing. Here’s how accounts receivable financing might work for your business.

What is accounts receivable financing?

The basic idea behind accounts receivable financing is that your business works with a funder to advance your company money on invoices that are either not-yet-due or outstanding. Your business receives a line of credit against those invoices that can either be used to make an investment in your business, keep cash flowing during a slow quarter, or other needs.

Marsha Kelly owned a cosmetics manufacturing company based in Hawaii. But when she was invited to sell it on QVC, she says, it was “both awesome and terrible.”

“Great because of the sale potential and brand exposure, bad because of the intense strain on our limited working capital.”

Her company ended up turning to accounts receivable financing to facilitate the QVS appearance.

“In order to purchase materials and labor to manufacture the large number of products QVC ordered, I used accounts receivable financing. Without this type of credit our company would have not been able to ship the items, nor would I have been on TV showcasing our line of Hawaiian perfumes with Don Ho!”

How do accounts receivable loans work?

Typically, when opening an accounts receivable line of credit, the lender examines the credit profiles of your clients. That’s because they want to ensure that you your business invoices will likely be paid. The lender will also consider the length of time any invoices have gone unpaid. The older the invoice, the less valuable it is because there’s a higher chance it won’t be paid.

Once a lender makes an evaluation of your business receivables, they can typically open a line of credit for you to access within 24 hours, eliminating one of the pain points associated with a more traditional business loan--the amount of time it takes to get approval and disburse, or pay, the funds.

Then, as your invoices are paid, the line of credit is paid off, minus any applicable fees you agreed to when opening the accounts receivable loan.

The costs to your business are a fee that you pay connected to the line of credit that you can access. When considering accounts receivable financing, it’s important to take into account the rate at which you’ll collect payment on invoices, because the longer it takes to repay the line of credit, the more you’ll pay in fees.

What is accounts receivable financing based on?

Access to accounts receivable financing is based on the amount of money due to your business. It also takes into account the credit worthiness of your clients and the age of the receivables. It might also be dependent on any liens associated with your business and your tax situation.

It can be a valuable financing option for some businesses that don’t qualify for other kinds of financing.

What’s the difference between factoring and accounts receivable financing?

Business owners sometimes confuse the terms accounts receivable factoring, or factoring, and accounts receivable financing. Factoring is different than accounts receivable financing because with receivables factoring, your unpaid invoices are actually purchased, and then it’s up to the factoring company, or purchaser, to collect on the invoices.

With accounts receivable financing, your clients wouldn’t typically know you’ve leveraged what they owe you to support cash flow or make an investment in your business.

How to choose the best accounts receivable financing loan for your business

Like with other forms of financing, you’ll probably be looking for the best terms on a line of credit for your business, i.e., the lowest rate or smallest fees at the longest repayment term for the amount of cash you need. But you might also take into account the ease of the application, the amount of funding possible (typically 80%, 90%, or occasionally 100%) and how quickly you can access funds.

As Richard Meers, a small business owner and commercial finance broker explains, “there are more options today than several years ago for business term loans with the introduction of more online lenders. These lenders typically offer rates 1 to 2 percent higher than a standard SBA term loan but they are more flexible with their underwriting criteria.”

Another point to consider is the flexibility of the funding. Some receivables financing companies will want to leverage all of your receivables, while others will allow you to choose which outstanding invoices you’d like to include in your financing, which could be important for some businesses. It’s best to shop around before applying for funding to make sure you’re receiving the best deal possible for your business.

Lastly, some of the possible fees you’ll want to be aware of when considering opening a line of credit can include application or processing fees, setup fees, withdrawal fees and servicing fees. Make sure you’re aware of any applicable fees, including the actual percentage you’ll pay on the funding, before signing an agreement.

How to apply for an accounts receivable financing loan

When you’re ready to apply for accounts receivable financing, you’ll want to gather the relevant financial information about your business.

The list can include:

  • An accounting or records of your unpaid invoices
  • Voided business checks
  • Bank statements
  • Your personal credit score or credit history (for some lenders, this won’t matter)
  • The typical annual revenue of your business
  • The length of time your business has existed

Once you’re ready, you’ll likely fill out an online application or visit a bank to submit your application. Once your application is approved, in many cases you’ll have access to the working capital you need in about 24 hours.