From Invoice to Income: How Accounts Receivables Financing Can Your Business Grow in 2023
Unlock the power of accounts receivables financing - the key to modern business’s growth.
Capital funding is a critical aspect of any business, and in today’s economy, various options are available to companies looking for financing. One popular option is accounts receivable financing, also known as factoring. This financing method allows businesses to borrow money based on unpaid invoices, providing immediate cash to cover short-term expenses.
On average, a whopping 93% of companies receive late payments from customers. And then, too, they write off 1.5% of their receivables as bad debt. Why do that when you can have them financed?
In this blog, we will understand what accounts receivable financing is. We’ll also go over the types of accounts receivable financing and its features and benefits. Let’s begin!
What is Accounts Receivable Financing?
Accounts receivable (AR) financing is a type of financing that allows a business to borrow money based on its unpaid invoices. It is also known as factoring.
With this type of financing, a business can sell its accounts receivable at a discount to a third-party lender, known as a factoring company, in exchange for immediate cash.
This type of financing can be helpful for businesses with a large number of unpaid invoices needing cash to cover their short-term expenses. It can be especially beneficial for companies that operate on thin margins and need to quickly access cash to cover their costs and maintain their operations.
Accounts receivable financing is also often used by businesses experiencing rapid growth or those engaged in a seasonal business, where cash flow can be variable.
Understanding Accounts Receivable Financing
Accounts receivables are invoices billed to customers but have yet to be paid. Since the money will come, but only with delay, these are treated as current assets on a balance sheet. Current asset means an asset that can be converted to cash within a year.
Accounts receivable financing is a way for companies to access cash quickly by borrowing money against the money they expect to receive from their customers soon.
It’s essentially a short-term loan backed by the outstanding unpaid invoices that a company has.
Think about it this way — Imagine you’re running a business, selling some products or services to other companies or people, and sending them invoices asking them to pay for what they bought.
But they’re taking a while to pay you back (and this could be for a host of reasons). Naturally, this can make it hard for you to pay your bills, like rent and salaries, because you don’t have all the money you need right away.
But since you know the money is coming in soon, you can use those unpaid invoices as collateral to borrow money from a lender. The lender will then wait for your customers to pay the invoices, and once they do, the lender will get their money back plus interest. This way, you can get the cash you need immediately, and the lender can make money off the deal.
It’s a way for companies to bridge the gap between when they make a sale and when they get paid, allowing them to maintain their operations and grow their business.
Accounts Receivable Financing Structuring
The structuring of AR financing can be broadly divided into two types:
Let’s discuss more about these in the following sections.
In some cases, accounts receivable financing is structured as an asset sale, in that the business sells its accounts receivables to the financier. The financier also takes responsibility for collecting invoices from its customers. These financiers buy the receivables at a discounted rate, expecting they will be able to collect the full amount of invoices plus profit.
In return, a financier pays the business up to 90% of the outstanding invoice value.
However, sometimes a business might have to write off the invoice. In this case, the amount it will have to write off depends on the agreed number in the deal. On the other hand, in some cases, if the financier can collect all the invoices, they may give extra money back to the business after the sale is done.
Most factoring companies will only buy accounts receivable invoices that they think will be paid soon. They avoid buying invoices they think won’t be paid (defaulted receivables). This is because they want to avoid taking on too much risk if there appears a possibility that customers won’t pay.
When a factoring company buys assets from a company, it transfers the risk associated with the accounts receivable invoices to the financing company. Factoring companies try to minimize this risk by focusing on short-term receivables and charging fees for their services.
The factoring company makes money by buying the assets at a lower price than they are worth and selling them at a higher price.
Instead of selling the accounts receivable invoices to a factoring company, a business can get a loan using the accounts receivable as collateral.
The loan can be structured in different ways, depending on the lender. One advantage of this type of financing is that the business does not have to sell its accounts receivable invoices. Instead, it gets an advance of money based on the accounts receivable balances.
The loan can be either unsecured, which means the business doesn’t have to put up any additional collateral, or secured, which means the business has to put up the accounts receivable invoices as collateral.
With an accounts receivable loan, the business must pay the money back over time, usually with interest. Unlike factoring, the business will not lose control of its customer relationships, as it is not selling the right to collect its accounts receivable to a third party.
Accounts Receivable Financing — Underwriting
Underwriting is the process of evaluating the risk of an investment and then deciding whether or not to onboard the company. Factoring companies consider several factors when onboarding a business, for example:
Size of the company: The accounts receivables of large companies are more valuable than small companies.
Age of receivables: The age of receivables influences financing terms — short-term receivables lead to better terms. Overdue receivables can lead to lower financing amounts.
The terms of the deal and agreed payment for accounts receivable balances vary from business to business.
Types of Accounts Receivable Financing
There are several types of accounts receivable financing, including:
Factoring: This is when a business sells its accounts receivable invoices to a third-party company (the factor) at a discounted rate. The factor then collects the money from the customers and gives the business the remaining balance minus a fee.
Accounts Receivable Loans: A business uses its accounts receivable as collateral to secure a loan from a lender. The business gets an advance of money based on the accounts receivable balances and must pay the money back over time, usually with interest.
Asset-Based Lending: This type of loan is secured by a company’s assets, including accounts receivable, inventory, and equipment. The lender advances money based on the value of the assets, and the business must pay back the loan over time, usually with interest.
Eligibility Criteria for Accounts Receivable Financing
The eligibility criteria differ with lenders; however, some general rules of thumb are as follows:
The age of applicant should be between 25–55 years
The applicant should have a minimum of three years of experience running the business
You should have filed income tax returns for the business
The following documents would be required:
A copy of your invoices
Proof of order supplied
You might also be asked for proof of identity, business ownership, and financial documents.
How to Apply for AR Financing Online
Most lenders, like BridgeUp, allow you to apply for financing by sending them an SMS or filling up a form online.
SMS: You can drop a text at the number given on the lender’s website. For example, with BridgeUp, you can drop a ‘Hi’ at +91-9819660287, and their representative will be with you in a couple of minutes.
Online: The websites often have a button along the lines of ‘Sign up,’ where you can click and sign up, and an executive would get in touch with you in a few minutes. For example, in the case of BridgeUp, you can fill out this form and have a representative contact you within minutes.
Features and Benefits of AR Financing
Some features and benefits of AR financing are as follows:
A business may be able to finance invoices worth Rs 30 lakh
In case of factoring, you’ll be assured that the agreement has you protected from the customer defaulting on the payment
You can secure the services of the factoring company or the financier online
You don’t need to have any asset as collateral to secure funding
Some lenders allow you to withdraw the amount required immediately and let you repay the withdrawn amount
Accounts receivable financing can be useful for businesses looking to improve their cash flow. But it also has its own set of risks and costs. Here are several advantages and disadvantages of AR financing.
Improved Cash Flow: Accounts receivable financing allows businesses to get paid for their invoices immediately rather than waiting for customers to pay. This can improve a business’s cash flow and help it meet its financial obligations.
No Debt: Accounts receivable financing is not considered debt, as the business sells its invoices rather than borrowing money. This means business owners do not have to worry about repaying the financing with interest, which can be beneficial for already heavily-leveraged businesses.
Flexibility: Accounts receivable financing is tailored to a business’s specific needs. You can use it for various purposes, including working capital, expansion, and acquisitions.
No Impact on Credit Score: Accounts receivable financing does not impact a business’s credit score, as it is not considered debt.
Cost: Accounts receivable financing can be expensive, as businesses typically pay a fee to the financing company. In addition, if the business opts for a loan, it may have to pay interest.
Loss of Control: When a business sells its accounts receivable invoices, it loses control of the collections process. This can be problematic if the financing company cannot collect the money from customers as quickly as the business would like.
Risk of Default: If a business’s customers default on their payments, the financing company may not be able to collect the money. This can result in the business having to write off the accounts receivable, which can be costly.
Reduced Margins: Accounts receivable financing typically involves selling invoices at a discount, which reduces the business’s margins and profitability.
Accounts receivable financing is a valuable tool for businesses looking to improve their cash flow and maintain their operations. It allows businesses to borrow money based on their unpaid invoices and can be especially beneficial for businesses that operate on thin margins and need to access cash quickly. It is recommended that you consider the advantages and disadvantages of AR financing for your business before committing to this capital funding method.
One such account receivable financier is BridgeUp, India’s premier recurring revenue platform.
BridgeUp evaluates a company’s revenue stream and provides a score. This score tells the team whether we can fund the borrowing company and to what extent. This process takes about a week.
To know more about how we can help you, give us a holler at +91-9819660287. Or you could fill out our contact form for more information and experience the ease of getting upfront capital with BridgeUp!
Accounts Receivable Financing FAQs
What is the difference between accounts receivables financing and invoice financing?
The main difference between accounts receivable financing and invoice financing is that in accounts receivable financing, the financing company owns the accounts receivable and collects payment from the customer. Whereas in invoice financing, the company retains ownership of the invoices and is responsible for collecting payment from the customer.
Why should you choose accounts receivables financing over loans?
With accounts receivables, you get faster access to funds without worrying too much about collateral or credit score. Plus, it is flexible and can be customized to suit the needs of your business. With accounts receivables financing, you also transfer the risk of default to the financing company, reducing your business’s overall risk.
Do the customers know their invoices are being sold or loaned?
When business owners utilize accounts receivable financing, they may sell their outstanding invoices to a lender. In such a scenario, the lender will inform the customers of the arrangement, and the payments will be routed to the lender directly.
However, in some cases, customers might not be aware of the arrangement and make payments to the business owner. In such instances, the business owner’s responsibility is to forward the payments to the lender, whether the financing method chosen is factoring or any other form of financing.