Easy Accounts Receivable Financing

Accounts Receivable Financing is it for you?

This financing is used by large and small organizations as a way to manage cash flow.

People are often confused about the term accounts receivables and which of these accounts can be used for financing.

Accounts Receivable?

Let’s define accounts receivable so that we are clear on what we are talking about.

Accounts receivable is the amount due when goods or services are delivered but not yet paid. Most businesses that work with other businesses have these types of accounts, and usually they occur because it is common for business customers to pay on terms that range from 30, 60 or even 90 days.

Accounts Receivable Financing and How Does It Work?

This loan is offered by banks or third parties. When a company takes out an accounts receivable loan, the financing institution will use the accounts receivables as collateral for that loan.

The ability to finance your accounts receivable is dependent on how likely the accounts can be collected.

Factors that influence lenders

A number of factors can influence a lender’s perception of the collectability of any account:

What is the age of the account (how many days past due)? The older the account the more risk there is to collect.
What type of item has been sold? Can it be repossessed if payment is not made, or is it a consumable item?
What is the average price of the item or items? The lower the price, the higher the risk.
What is the customer’s payment history?

Types of accounts receivable financing

When you’re considering using your accounts receivable to obtain financing, there are two main types with which you need to be familiar.

The two main types of accounts receivable financing are:

Secured Loan
Asset Sale

Secured Loan

With this type of financing, the accounts receivables are listed and offered to a financing institution as collateral for the loan.

As you might expect, the better the accounts, the easier it will be to obtain financing. accounts receivables are listed and offered to a financing institution as collateral for the loan. As you might expect, the better the accounts, the easier it will be to obtain financing.

If your business is strong consider the short term business loan.

Advantages for the secured loan type of accounts receivable financing:

You maintain control and ownership of all of your receivables. No other entity will contact your customers for payment, unless authorized by you.
Your customers continue to pay you as agreed because you maintain control of your accounts receivables.
Interest rates should be tied to the prime rate, and may be lower than other forms of financing.
This type of financing can be structured as a line of credit that is secured. This has the advantage of allowing you to use what you need, and to increase the line as receivables go up without incurring extra cost.

Risks for this type of accounts receivables financing:

Requires more information to be provided on the application, for example: balance sheet, P&L, statement of cash flows, and aging reports on the accounts receivable.
It can take longer to be approved.
Fewer institutions may be willing to offer this type of financing.
A line of credit against accounts receivable may be reviewed by your financial institution every year to make sure your business ratios are in compliance with the terms.

Asset Sale

This is commonly referred to as factoring.

This type of financing tends to be available very quickly, but it requires that you sell your accounts receivables to the factoring company, and you are, in effect, no longer in control of, or responsible for, collecting on these accounts.

In this type of financing there are subtypes to be aware of.

Factoring subtypes

Selective receivables finance
Asset-based lending (ABL)
Traditional factoring

Selective receivables finance provides the factor the ability to pick which accounts they are willing to use for financing. This reduces their risk and often means that you will be paid quickly. Because selective financing also reduces risk, it should also reduce the cost to you. However, you will likely need to carefully manage which accounts you collect directly, and which are collected by the factoring company.

Asset based lending is usually associated with higher fees, and is often needed when there are not enough prime accounts for the selective option to be utilized. When exercising this option, the business will commit the majority of their receivables and will not have a say as to what accounts are committed.

Traditional factoring allows the business to determine which accounts receivable to sell to the factoring company. With this model, your business will often pay higher fees and will receive less of an initial payment.

Advantages for the factoring or sale of asset

approach to accounts receivable financing:

It is quick and usually does not require a lot of paperwork.
There are a large number of factoring companies to choose from.
You can focus on sales and not on collections as this is now the responsibility of the factoring company.
This tends to be a good option for a business that is growing rapidly with a lot of new customers and needs fast cash to maintain growth.

Disadvantages for factoring:

You give up control over some or all of your accounts receivables. You have sold them to another company, so you must be careful and understand completely how the factoring company will treat your customers.
You will need to contact your customers to inform them that you have sold their accounts receivables to another company and that they will be collecting. Developing clear and consistent messaging is important to make sure your customers know when to work with you versus the factoring company.
Costs tend to be higher.
There can often be terms in the contract that will keep your company responsible for any uncollected accounts, even though you are no longer responsible for the collection.
Included in the contract can also be terms that pay you only a percentage of the face value of the account until it has been paid.

Who uses accounts receivables financing?

Businesses that use accounts receivable financing range across the map.

They can be:

strong growth companies
small businesses that have had unexpected cash needs
businesses that a new opportunity
acquisition strategies that include Leveraged By-Outs (LBOs).

Pluses and Minuses of Accounts Receivable Financing

The pluses of accounts receivable financing:

Usually no credit check, and no pledging of other assets is required.
The ownership of the company remains intact and is not diluted as it might be if an additional investor was taken on.
It can be the quickest way to gain access to cash, sometimes as fast as 24 hours.

The minuses of accounts receivable financing:

Higher costs. Accounts receivable financing gets you money quickly but it often comes at a high cost. It is not unusual for it to cost more than what you would pay for more conventional forms of financing. And if the financing costs exceed your unit profit margin, then you could be losing money on each sale.
Contracts are not standard and have to be carefully reviewed before signing.
Each company that provides this type of financing tends to operate its own unique set of policies and procedures.

The 6 Steps to Get Accounts Receivable Financing

Accounts receivable financing is pretty simple to secure—you just need to know these six steps:

Review your accounts and determine which you would like to finance.
Look for a finance company that is willing and able to finance the accounts receivables and category that you will use
Review the selected loan contracts and make sure you understand all of the commitments required before you sign.
Apply for funding.
The lender will advance you the amount determined by the contract you’ve signed and agreed to.
Be prepared to pay weekly fees until the account is settled with the lender.

There are many types of financing available to businesses. Accounts receivable financing fits an important need for many businesses when cash is needed quickly for many justified reasons.

Three ways to get additional business capital for your business

Accounts receivable financing frequently asked questions

What is an accounts receivable factoring?

This is when a company that has accounts receivable is able to sell those accounts to a third party and receive immediate payment. The third party can be responsible for collecting or not, and often charges fees and a percentage of the value of the accounts receivable.

How do you finance accounts receivable?

This is done by going to a third party lender also known as a factoring company. They will provide their terms and conditions, which can be widely different depending on the company and the quality of your accounts receivable. You can also apply for a loan or line of credit from a bank using your accounts receivable as collateral.

Is accounts receivable financing good or bad?

Making the right decisions on timing, the third party providing the loan, and the fees paid, makes all the difference if this will be a good or bad decision. If it is done well it can be very advantageous to the company, and provide strong liquidity while reducing collection costs.

Is factoring a good option for an organization to control receivables?

It can be very effective if there is a need to maintain a certain level of cash flow.

What is the difference between factoring and accounts receivable financing?

There are significant differences between factoring and accounts receivable financing. It is not uncommon to see these terms mixed up and used with the same meaning. Accounts receivable financing usually involves a bank and they will finance your receivables, using them as collateral for a loan or line of credit.

Factoring, on the other hand, means that the third party will actually take ownership of the accounts receivables and provide a lump sum payment that is usually 70% to 90% of the value. The full face value of the accounts receivables are paid when the accounts are collected, minus fees incurred along the way.

How do you calculate accounts receivable turnover ?

To calculate Accounts Receivable Turnover, add together the beginning and ending accounts receivable balances and divide that sum by 2 to get the average accounts receivable for the year. Then divide that result into the net credit sales for the year.

Example:

Beginning Accounts Receivable: $150,000

Ending Accounts Receivable: $250,000

Net Credit Sales: $3,000,000

Equation: $150,000 + $250,000 = $400,000 / 2 = $200,000; $3,000,000 / 200,000 = 15. Accounts Receivable Turnover = 15 times per year.

What is a good accounts receivable turnover ratio?

To answer the question you first need to know what the payment policy for the company is, and then compare this to the industry standard. The higher the number, the more times per year the company is collecting it’s outstanding receivables, and the better its cash flow will be. The smaller the number, the less times per year the company is collecting its receivables.

How to calculate the accounts receivable turnover ratio:

Divide net credit sales by the average accounts receivable balance. This is done by finding the average account receivables value for a period, then dividing the total credit sales for the period by that number

How do accounts receivable loans work?

There are two types: one is to sell the accounts receivables to another company, the other is to use the accounts receivables as collateral on a loan or line of credit.

Once you’ve made the decision on which to use (both have pros and cons), find a company that offers that type of financing.

Then complete the application and approval process in order to receive financing for your accounts receivable.

Accounts receivable financing vs loans, which is better?

This depends on a number of factors like: how long you need the loan for, does it need to be like a credit line, do you need access to cash quickly?

Answering these questions helps to determine if the accounts receivable financing is the right way to go. Both accounts receivable financing and loans have pluses and minuses that can be good or bad for a company depending on their situation.

How is an accounts receivable loan treated on the balance sheet?

It is considered to be a liability. The amount of payments due within one year, or within one operating cycle, are listed in the Current Liabilities section, and the amount of payments due later are listed in the Long Term Liabilities section.

What is an example of an accounts receivable?

Any time a customer does not immediately pay for a product or service.

What are the disadvantages of factoring?

Factoring is considered to be a sale of the accounts receivable assets.

Disadvantages are:

you no longer have control over your accounts receivables,
Another company controls the collections from your customer accounts, including contacting customers for payment and demanding payment.
You may not get full value for your receivables accounts,
Cost is typically higher than other types of financing.

What are the benefits of factoring?

Tends to be quick and easy to get
You no longer worry about collecting on accounts receivable
As sales grow it is easy to increase financing, good for fast growing companies or startups when there is little history