What Is Accounts Receivable Financing?

For many businesses, accounts receivable represent a large component of the balance sheet. As more buyers require suppliers to accept longer payment terms, A/R balances are growing at the expense of the supplier’s cash conversion.

In order to improve liquidity, many businesses are turning to accounts receivable financing to unlock the value in their outstanding invoices. A/R financing companies provide businesses upfront cash availability against open invoices. As invoices are created and billed to customers, the business simultaneously presents these invoices to their financier.

Accounts receivable financing, also called accounts receivable factoring, is the process of financing outstanding invoices in order to access the cash value sooner. Many businesses have slow-paying customers and long payment terms, anywhere from 30-90 days, resulting in cash flow problems. While those invoices are considered an asset on their balance sheet, the invoices are not a liquid source of capital until they’re paid.

Accounts receivable financing companies, also called a factoring companies, provides financing related to a portion of the face value of a business’s outstanding invoices.

The accounts receivable financing provider will perform due diligence on you and your customers, completing background and credit checks and verifying invoices which determines if they are legitimate and likely to be paid. Depending on their evaluation the provider will then approve your invoices for financing.

Once approved for accounts receivable financing, you are free to submit invoices for funding pretty much immediately. The provider will finance anywhere from 70-90% of the invoice face value, holding the remainder in a lockbox until your customer pays their bill. Once paid, the provider will release the remainder back to your business, minus a factoring fee – typically 1-5% depending on your contract terms.

To make it easier to understand, we’ve outlined the steps below.

1. You complete work and invoice your customer
2. You submit that invoice to an AR financing company
3. AR financing company advances 70-90% of the invoice value
4. Your customer pays their invoice to the AR financing company
5. AR financing company releases remaining amount, minus a financing fee

AR-based lines can be priced in a variety of ways. The flexibility in structure can benefit both the business and the Accounts Receivable Finance company by allowing for maximum flexibility in developing a solution that benefits each party. Unfortunately, this same flexibility in pricing can make it difficult for business owners to grasp all-in costs and can make pricing comparisons amongst lenders seemingly impossible.

In addition to an interest component, accounts receivable financing companies may utilize lockbox fees, service fees, processing fees, monitoring fees, transaction fees, unused line fees, and other ancillary charges in order to achieve their desired return.

Wading through all this noise and determining an all-in rate can be painful, but keep in mind the primary drivers in your Accounts Receivable Financing costs include the size of your financing needs and the credit quality of your customer base.

Accounts Receivable Financing Rates Explained >

Like any financing solution to boost net working capital, AR financing has its advantages and drawbacks. Before moving forward with AR financing, you should be aware of both the good and the bad, making sure that you’re informed and won’t be caught off guard. Here’s how to identify the best factoring companies:

• Rapid funding
  • You can get approved for AR financing within as little as 24 hours. That’s considerably faster than any other type of bank loan or line of credit, which can take weeks to months until you see your cash.
• Easier approval
  • The provider cares more about your customers’ creditworthiness and operating history than yours. For that reason, it’s much easier to get approved for AR financing than traditional lending (assuming your invoices check out!)
• No impact on credit
  • AR financing isn’t really a loan – it’s a sale of an asset. That means that it doesn’t impact your credit, and it isn’t recorded as debt against your business.

• The stigma
  • Whether we agree or not, there’s a certain stigma about AR financing, or invoice factoring. That’s because it hasn’t always worked out for everyone. Shady, untrustworthy providers have given customers a bad taste in their mouths. That’s why you have to be careful who you choose.
• More expensive
  • There’s no question that AR financing is more expensive than a traditional loan. When you submit an invoice for funding that’s on net 30 payment terms, you’ll likely pay 2-3% of the total invoice value in fees. That’s a large percentage for 30-day financing. However, it all depends on how valuable that cash is to you now, vs. if you simply waited for your customers to pay.
• Long, deceptive contracts
  • Some AR financing providers will make a bunch of promises, in terms of rates and fees, when they’re onboarding you. Sometimes they’ll include hidden fees and covenants within your contract that can make financing deceptively expensive. Make sure you read the fine print and ask questions!

Read more about the advantages and disadvantages of AR financing.

With AR financing becoming more and more popular in recent years, there is an ever-increasing number of factoring companies vying for your business. That can make it difficult to determine which is best for your business.

Here’s a list of questions you should ask before signing a contract:

• Do they have experience within your industry?
  • Your factoring or AR financing company should be familiar with your specific industry, be that staffing, construction, transportation, manufacturing, etc. Each industry is different, and can require unique underwriting. Make sure your provider has worked with other businesses like yours.
• How do they structure their fees?
  • There are numerous ways for an AR financing provider to structure it’s fees. Make sure you pay attention to the details and ask plenty of questions. Here are a few of the different kinds of structures and fees you may encounter:
    • Whole-Ticket vs. Spot Financing
    • Recourse vs. Non-Recourse
    • Float Fees
    • Mandatory Minimums
    • Termination Fees
• How long have they been in business?
  • You probably don’t want to work with a provider that’s new to the factoring industry. It can take a couple years to build up the necessary team and operational efficiency that will make a provider work best for you. If the AR financing company is too young, you may want to keep looking around.
• Are they a bank, or an independent financing company?
  • A bank factoring company is generally less risky than an independent factoring company. That’s because they’re a direct source of funds, meaning they don’t have to borrow from a third party in order to finance your invoices. A bank is also more regulated than an independent financing company, which will help you feel more secure about partnering with them.
• Do you feel like you can trust them?
  • This one is all about your own perception and interaction with the AR financing company representatives. When you first spoke with them over the phone, perhaps after submitting a quote request online, did they sound trustworthy? Were they up front about their fees? Did you feel like they were trying to pull the wool over your eyes? These are all important questions to ask yourself up front – make sure you find a provider you can trust!

Both invoice factoring and accounts receivable financing benefit businesses by providing funds in advance of collection. When cash flow timing matters most, both of these alternative financing options quickly put money into the business. In addition, both offer professional credit services and receivables management.

The main difference between invoice factoring and accounts receivable financing lies in the underwriting criteria of the deal structures. While factoring offers greater flexibility, AR financing has more strictness around the credit profile. Consequently, AR financing typically offers preferred financing terms. Some businesses use these terms interchangeably, as factoring is a specific form of accounts receivable financing.

There are a number of questions to ask yourself before determining if AR financing is a fit for your business. Not every business has the same customers, payment terms, operating history, etc., and thus there’s not one type of financing for everyone. Not all business use COD payment terms. Some businesses have established credit and can efficiently acquire bank loans. Others sell products and services that aren’t capable of being factored.

Here are the top four indicators that your business is a fit for A/R financing:

1. You sell B2B (Business-to-Business)
2. You haven’t been in business for very long
3. You have bad, or unfavorable, credit
4. You have long payment terms on your outstanding invoices

If you’re thinking AR financing could be a good solution to your working capital problem, apply today. Unlike most other AR financing providers, altLINE is a bank. That means we’re a direct source of funds, reducing our borrowing costs so we can pass on more savings to you. As a bank, we’re also fully regulated which means we’re we’re more transparent and trustworthy than the competition. Find out more about why Investopedia, Forbes, Nerd Wallet, TheBalanceSMB, Fundera, Solution Scout, Merchant Maverick, FitSmallBusiness, and Business.com rated us Top Factoring Company.