Inevitably, there will come a time for your business when cash flow will not be as steady as you would like. Some companies experience periodic slow seasons, while others may find themselves short on funds due to an unexpected closure or pandemic. Whatever the reason, finding yourself without cash to pay employees or key suppliers is a nerve wracking experience for any business owner to face.
Luckily, there are options to help supplement your cash flow, one of the most popular being accounts receivable financing.
Accounts receivable financing is a financing solution that uses outstanding invoices from your clients as collateral, similar to a traditional secured loan. AR financing is more flexible than traditional loans since the creditworthiness of your clients is the deciding factor rather than your own.
Below is a guide to how AR financing works, so you can determine if AR financing is the right solution for your company’s cash flow needs.
Types of Receivables Financing
With invoice factoring, the unpaid invoice is the collateral, so it’s up to your client, not you, to pay the financing company back. With AR financing loans, while the onus is still on your business to pay back the loan, the loan is more stable since there is a definitive source that the money should be coming from.
Accounts receivable factoring, also known as invoice factoring, differs from other types of business financing for one main reason. Rather than opening a line of credit with a financing company, that will then be paid back by your company over a set period of time, AR factoring companies will buy your clients’ invoice from you directly, give you a certain percentage of the invoice upfront, and then have the client pay the invoice back to the financing company.
For more information on how invoice factoring works, and if it may be right for your company, check out our guide of the best invoice factoring companies of 2021.
AR Financing Loans
AR financing loans are more akin to traditional lending than invoice factoring is, but still has some key differences.
The main difference is that your client’s unpaid invoice acts as collateral for the loan. While you’re still on the hook to make the payments, you can generally find more favorable terms than with an unsecured business loan at a commercial bank, since there is a far higher chance of you being able to pay back the loan on time.
Another difference is how the underwriting process works. For traditional bank loans, the financier will mainly look at your company’s debt-to-income ratio and credit score, particularly your payment history, to judge your creditworthiness. With accounts receivable loans, the financing company is more interested in the value of the invoice and the creditworthiness of your client, since the invoice is the collateral.
AR loans are also usually not counted as debt, so they won’t show up on your balance sheet, or affect any other loans you may be considering.
AR loans are generally very flexible about how you use the funds. However, many companies do have restrictions on using AR loans as a refinance option to pay off other loans.
The higher the invoice, the more the AR financing company is paid, so bigger companies with more revenue per month can get better rates and terms than smaller companies or sole proprietorships.
AR financing companies also prefer newer invoices, since older invoices (for example, invoices that have been outstanding for 90 days) are more likely to be forgotten and go unpaid by clients, and many financing companies consider them to be in default. Some factoring companies have a limit of the payment terms of the invoice itself to limit the risk of the loan going into default, usually asking they be capped at net 60.
Receivables Financing Qualifications
Every AR financing company will have different minimum funding requirements, but in general, the financing company will want to see that you (and your client, if you’re considering AR factoring) can be trusted to pay back the loan. On the whole, since this financing has collateral, the barrier for entry is much lower than with traditional bank loans.
Many AR companies require your business to be in operation for a certain time period, usually between 3 months and 1 year, and to show that you have at least some history of revenue. Some companies may have minimum revenue requirements as well. If a company requires a minimum credit score, it’s usually only 500.
Some AR loan companies may decline your application if you have a recent history of bankruptcy or liens on your business.
There are a few factors to consider if you’re wondering whether receivables financing is right for your business.
While no one wants to wait to get their money, some companies rely on fast and steady cash flow more than others. For example, trucking and transportation companies make up a large portion of receivables financers, since they need to maintain and fuel their vehicles, and make sure their drivers are promptly paid so that they can take care of their own needs while on the road. Sanitation and janitorial companies also tend to rely on AR financing, since they constantly need to restock supplies.
If you plan to use your advance payment to pay off another loan or debt, however, AR financing probably will not help you very much, and in fact many companies have restrictions on using AR financing services as a type of refinancing.
Short or Long Term Financing
While AR financing can be a great source of cash flow in the short term, it is not meant to be a long term financial fix.
AR financing works on the assumption that a payment is upcoming to your company in the very short term (within the next 90 days, generally), and that your clients can be relied upon to pay back your invoice within a reasonable amount of time.
If your cash flow issues are coming from consistently low sales or clients who are habitually late with payments, AR financing could actually be more of a hindrance to your company than a help, especially if it forces you to default on an AR loan.
One of the great things about AR financing is that your company’s creditworthiness is far less important than your clients’ in most cases. However, that also means that you have to be able to trust that your clients will in fact fulfill their invoices, so that you don’t face any chargebacks.
If you’re considering AR financing because of a customer who is consistently late on or missing payments, you may find yourself in more trouble rather than less, since financing companies will seize part of or even all of your invoice if the payments are not fulfilled.
If inconsistent payments are a recurring issue, you may want to consider changing the terms of the contract with your client or dropping them altogether, rather than apply for accounts receivable financing.
Best AR Financing Companies in 2021
|Funding Requirements||3 months of operations, credit score of 500+, no history of bankruptcy or liens.|
|Advance Amount||100% of your invoice amount. Can finance between $100 and $100,000 per invoice.|
|Rates||12 to 24 week repayment periods, with rates starting at 4.66%.|
|Features||Automatic deductions from your business bank account so you don’t have to worry about missing a payment. No early repayment penalties.|
|Funding Speed||Initial approval takes a matter of hours, and funds can be available the next business day.|
1st Commercial Credit
|Funding Requirements||No financials required.|
|Advance Amount||100% of invoice amount. Can finance invoices between $10,000 and $10 million.|
|Rates||Financing rates are between 0.69% and 1.59%.|
|Features||No facility fees or audit fees.|
|Funding Speed||Initial account set up usually takes 3 to 5 business days.|
Final Thoughts on AR Financing
AR financing can be a great solution for your business if you’re strapped for cash. With its low barrier of entry, lightning fast funding times, and generally low rates, accounts receivable financing has remained a popular business solution for a reason. Many business owners find peace of mind knowing they can access capital if they need to.
However, receivables financing is not a one size fits all solution for every business. If your business finds itself with a consistently stifled cash flow, AR financing may just be a bandage on a larger problem. If you’re a B2C company, mostly focused on selling services to the public, financing accounts receivable will probably not work for you. If your clients are consistently late with payments or just don’t pay at all, financing companies may consider your invoices too risky to work with.
If accounts receivable financing is the solution your company is looking for, though, we highly suggest taking a look at the companies above knowing you’re in good hands.
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Blake Bobit has been an entrepreneur and business owner for over 25 years. He founded Solution Scout to provide the most helpful answers to questions about business solutions. Blake provides strategic advisory services to businesses in many industries nationwide and is passionate about helping others reach new levels of success.