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Accounts Receivable Financing

By Elise Moores Updated on May 03 2021

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A Guide to Invoice Factoring

As much as we’d like them to, invoices aren’t always paid on time. And even when they are, repayment terms often leave you with gaps in your cash flow as you wait for 30, 60 or 90 days to get paid. 

When you’re counting on this capital to maintain day-to-day operations, pay staff and support growth, it can put your small business under unnecessary financial strain.

But what if you could get paid now for the work you’ve already delivered? 

With accounts receivable (AR) financing, you can.


What Is Accounts Receivable Financing?

Accounts receivable financing, also called invoice factoring, is an advance a business owner takes out against unpaid invoices. 

An accounts receivables financing company gives you a percentage of your invoice’s face value. Once your customer pays you and you settle your debt, the invoice financing company forwards you the remaining balance, minus their fee.


How Does Invoice Financing Work?

Step 1. Invoice Selection

Select the outstanding invoices you wish to finance. 

Step 2. Accounts Receivables Financing Company Deposits Capital

Lenders advance you a percentage of the invoice value. The amount you receive will depend on several factors, including the size of the invoice and the industry of your customer. Typical advance rates fall within the 80% to 90% range.

Step 3. Fees Accrue

The cost of invoice financing will depend on the time it takes your customer to pay. Accounts receivables financing companies charge a weekly fee, known as a factor, until the debt is satisfied. At which point, the reserve balance, minus fees, is forwarded on to you.


What Are the Types of Accounts Receivable Financing?

The terms “accounts receivable financing”, “invoice financing” and “invoice factoring” are often used interchangeably — and we do so in this work. But the terms can refer to different financing products depending on how they’re used, as accounts receivable financing can be structured as an asset sale (called factoring) or as an invoice-backed loan, line of credit or advance.  Here’s how the two structures differ. 

Factors purchase invoices while a lender servicing an accounts receivable loan, line of credit or advance accept invoices as collateral. 

In an invoice-backed loan, advance or line of credit agreement, you own the invoice and the customer relationship. That means all collection processes stay with you. In contrast, invoice factors take this responsibility over, as they, not you, own the invoice.

To be clear, the funding product described in this work is, by definition, invoice factoring (asset sales).  

Accounts receivable financing structured as an advance, loan or line of credit is described in more detail here: Invoice Financing Guide.


When Does It Make Sense for a Business to Consider Accounts Receivable Financing?

If you operate in the business-to-business (B2B) space and issue invoices with clear repayment terms, you’re eligible for invoice financing. It’s an especially useful tool if you work in an industry with long payment cycles, as financing receivables allows you to tap into the cash that’s tied up in that process.

What’s more, as lending decisions are based primarily on the quality of the invoices themselves, the review process is far faster than you’d experience when applying for a conventional small business loan. In fact, funds are issued the same day you apply in many cases. 

Consider invoice financing if:

  • You operate in the B2B space and you carry a high receivables balance
  • You’re experiencing a short-term cash-flow shortage
  • You’re presented with a business opportunity, but you don’t have the cash reserves to support it

What Do the Best Invoice Financing Lenders Look For?

Typically, the following invoice characteristics will result in the most favorable accounts receivable financing rates and terms:

Newer Invoices

Newer invoices are seen as more valuable since the possibility of payment is more likely compared to older invoices. You can increase your chances of qualifying for accounts receivable financing if your invoices have been newly issued. 

Larger Companies

Lenders find invoices more valuable if a larger business with significant annual revenue is responsible for payment. On the other hand, if your client lacks working capital, you may not qualify due to the risk that comes with your invoice.

Smaller Invoices

Small invoices are less of a gamble to lenders. The less money your client owes, the more likely they are to pay.


What are the Pros and Cons of an Accounts Receivable Advance?

Pros

  • Improved cash flow: Late payments can put a strain on cash flow. By taking out a loan against receivables, you gain access to cash without having to ask your clients for immediate payment.
  • Better borrower accessibility: To get approved for a conventional loan, banks often require collateral, a solid credit score and years in business. However, many small business owners don’t meet these requirements. Because accounts receivables financing is based on the likelihood that an invoice will be paid, you don’t need to provide collateral. Your customer’s ability to repay their debt is what matters most to lenders.

Cons

  • High costs: Invoice financing has higher rates than many other small business financing products. Additionally, if you fail to pay back your advance within the agreed-upon repayment term, your total repayment amount will increase.
  • Holdbacks: Your accounts receivable provider will typically keep a portion of your invoice funds until your invoice is paid in full.

How Much Does Accounts Receivable Financing Cost?

The cost of accounts receivables financing comes down to 3 things: 

  1. How long it takes your customer to pay
  2. Your lender’s fees
  3. Your quoted factor rate

Though fees vary by lender, expect to pay a single processing fee on each invoice you finance and a weekly factor until the invoice is paid in full.

To help you understand this cost structure, examine the example below or use our accounts receivable financing calculator.

Accounts Receivable Financing Cost Example

The invoice financing company charges a one-time processing fee of 3% and a weekly factor of 2% of the total value until the invoice is paid in full.

If you finance an invoice for $20,000, the cost structure will look like this:

Amount of financed invoice: $20,000
One-time 3% processing fee: $600
1.02 weekly factor rate: $204/week

An invoice financing company advances you 85% of the funded invoice.

Amount of financed invoice: $20,000
85% advance rate: $17,000

It takes your customer a total of 3 weeks to repay the invoice. As a result, the invoice financing company deducts $1,212 from the reserve amount.

FeeWeeks to RepaymentTotal
One-time 3% processing fee$600N/A$600
1.02 weekly factor rate $204 per week3$612
Total Invoice Financing Cost: $1,212

The invoice financing company issues a $1,788 rebate.

Reserve$3,000
Total invoice financing cost$1,212
Rebate owed to customer: $1,788

 


How Do I Qualify for Accounts Receivable Financing?

One of the benefits of accounts receivable financing is that your customers’ financial qualifications (not your business’s) are what matter most to accounts receivable lenders. 

The best accounts receivable companies will perform a reputational analysis, business credit check and a thorough examination of your customer’s payment history with your company.

While the health of your business is less relevant, it still comes under review and influences offered advance and factoring rates. 

Though program eligibility differs from provider to provider, most businesses will qualify if they meet the following conditions:

  • Time in business: 1+ year
  • Annual revenue: $150k+
  • Credit score: 600+ 

  • Complete our simple and secure application, and we’ll pair you with lenders for accounts receivable financing. 

    Applying is fast, easy—and most importantly—won’t impact your credit.

    Learn More

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