For many small businesses, cash flow problems are inevitable. And when your biggest cash inflows are tied to slow-paying receivables, your business is left in an especially vulnerable position. Accounts receivables financing may be just what your business needs to bridge temporary gaps in liquidity.

Accounts receivable (AR) financing is a lending product that enables companies to convert outstanding invoices into instant cash. You select the outstanding invoices you wish to finance. a lender advances you up to 90 percent of the total accounts receivable value and the remaining balance is withheld until all financed invoices are paid in full. At that time, the reserve is remitted back to you, minus an overall processing and weekly factor fee (more on that later).

This type of financing is ideal for B2B businesses carrying high accounts receivable balances. What’s more, it differs from traditional loan types in that you’re not generating any debt. You’re merely leveraging money that’s already owed to you.

To learn more about how accounts receivable financing works, and how it can benefit your business, read on.

Accounts Receivable Financing: An Overview

Regardless of your current cash situation, rent needs to paid, payroll needs to be met and general operating expenses need to be addressed. But if a significant portion of your cash reserve is tied up in unpaid invoices, it can leave you hard-pressed to meet these financial obligations. Fortunately, an accounts receivable loan allows business owners to cash out the value of their unpaid invoices for a fee.

Receivable finance, as it is sometimes referred, provides instant cash relief when you would otherwise have to wait weeks—even months—for customer payments.

Invoice financing for your small business provides a low-cost solution for fulfilling your company’s financial obligations while staying clear of costly, high-interest debt. Generally, AR financing offers the following key benefits to applicants:

  • Near-immediate access to cash
    You can be approved in hours and funded as fast as same day.
  • Easy application process
    Applying for traditional loans is notoriously a time-consuming process that requires a lot of paperwork. This is not the case with AR financing. The online application takes only minutes to complete and asks for simple business details and contact information.
  • Low qualification requirements
    If you’ve been turned down by banks, this may be the financing solution you need. Approval, advance and factor rates are primarily based on the credit of your customers, not your business.
  • No collateral required
    Invoices act as collateral, so no additional collateral is needed.

AR Financing: How Does It Work?

Before you apply for invoice financing, make sure you know the ins and outs of the application process and what risk you assume when your financing approval goes through.

Generally, lenders are most interested in high-value receivables. What makes a receivable high value?  

  • Large, creditworthy companies: Accounts receivable financing applications are most likely to gain approval if they contain invoices issued to established companies with strong annual revenues and histories of timely repayment.
  • Newer invoices: You can increase your chances of qualifying for accounts receivable financing if your invoices have only recently gone past due (between 30-90 days).
  • Smaller invoices: Small invoices are less of a risk to lenders for the simple reason that the less a company owes, the more likely it is to pay.

Though the creditworthiness of your business is less of a deciding factor, the health of your business and your accounts are relevant. When reviewing an application for accounts receivable financing, a lender will consider:

  • Your company’s average collection period (days outstanding)
  • Your customer mix (the number of customers you have and how your sales are distributed among them)
  • Your company’s invoice volume

In general, the shorter your collection period, the more diverse your customer portfolio and the higher your invoice volume, the better.

Once approved, the lender will deposit a capital infusion of up to 90 percent of the approved amount in the form of a cash advance.

The invoice financing agreement will delineate the weekly fees to be paid in exchange for the service. For every week that your client withholds payment, an additional fee will be levied against your account. This fee is known as a factor (or discount) rate. Once the invoices are paid, the lender issues you the reserved balance, minus the fees. These steps can be summed as follows:

  • Select the highest-value invoices you want to submit
  • Apply for AR financing
  • Wait for 80-90% cash advance
  • Accrue weekly fees until the outstanding balances are paid out
  • Receive reserve from the lender

Should You Consider Accounts Receivable Financing?

If your company is suffering from delayed cash flows, applying for invoice financing can be a great way to get yourself out of the crunch. Receivable finance options are ideal for B2B or B2G businesses with outstanding receivables that have experienced at least one of the following scenarios:

  • Sustained cash flow deficit
  • Unmet seasonal demands
  • Unpaid recurring expenses
  • Forgone growth opportunities due to insufficient cash reserves
  • New talent cannot be hired

For those that are experiencing the above signs of distress, AR financing may be the solution you need.

Receivables Financing: Averages, Rates and Cost

The market rates for receivable financing vary according to the lender and the value of the invoices. If you were to compare the cost of receivable financing to a typical loan, the annual percentage rate (APR) might be between 12 and 65 percent. As we mentioned above, factors such as the age and value of the invoices help ascertain the rate your business will be charged.

Since larger outstanding balances carry a high-risk, high-reward payout, they are often accepted at a higher cost than mid-sized invoices from reputable firms. Customers with a history of late payments can end up costing you when it comes to getting approved for finance receivables. In short, your customer’s reputation matters.

Pros and Cons of Receivable Financing

Whenever you borrow money, you accept a degree of risk as well as a monetary cost in the form of interest or a one-time or recurring fee. Below, we break down the tradeoffs associated with receivable financing to help you decide whether it’s a worthwhile cost for your small business.

Advantages of AR Financing

Small businesses that haven’t yet established a positive credit history stand to benefit most from AR financing, including:

  • A fast, straightforward application procedure
  • Same-day cash advances available
  • Funding amount tethered to the value of the invoices
  • No additional collateral needed
  • Approval based on your customer’s credit history

Disadvantages of AR Financing

Like any financing method, receivable financing comes with its share of negative aspects. Here are some of the risks inherent to AR financing that small business owners should be aware of before they apply:

  • You pay more in fees the longer your customers take to pay
  • Customers with bad credit history can get your application denied
  • You are liable if the customer defaults
  • Fees are higher than LOCs and term loans

How Is AR Financing Different From Invoice Factoring?

“Accounts receivable financing” and “invoice factoring” are two financial terms that are often used interchangeably. But “invoice factoring” often has a different connotation. The essential difference between “factoring” and “financing” lies in who is responsible for collecting payment from the customer.

With “factoring,” the lender takes control of the account and is responsible for chasing down customers for settlement of their invoices. With accounts receivable “financing,” your business retains control,  and you will chase payment in the usual way. Additionally, your customers will continue to remit payment to you and not the Factor.

Qualifying for a Receivable Finance Loan

Whereas term loans and traditional bank loans are highly selective with those they lend to, a small business without a credit history can get approved for AR financing with little trouble. The catch, however, is that their invoiced customers must have a solid track record of making payments. Otherwise, financing the invoices carries too great of a risk to the creditor.

If you don’t have an excellent FICO score, you can still qualify for receivable financing if your customers are reputable and creditworthy. Specifically, applicants are usually held to the following eligibility requirements:

  • Creditworthy clients and customers
  • $150,000+ in annual revenue
  • A calendar year in business
  • 600+ credit score
  • Have receivables that are outstanding
  • B2G/B2B business that issues invoices

What’s Your Best Option?

Ultimately, receivable financing is a good short-term solution to tide you through a cash crunch. If you need cash in a hurry, make sure you find a lender that offers terms suited for your business’s long-term needs. Just be mindful of any hidden fees so that you don’t break the bank in the process.

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