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What is Accounts Receivable Financing?

There are many ways that companies can get the financing that they need, when they need it. In cases where traditional loans are not the preferred method, accounts receivable financing can be an effective option. A/R financing can deliver capital right away that you can use to help your business grow. When used the right way, it can give you that extra liquidity that your company needs while also reducing its overall risk. Here is a deeper look at how accounts receivable financing can help you grow a company quickly. 

What is Accounts Receivable Financing?

Accounts Receivable Financing, also referred to as A/R financing is a way of turning A/R invoices that have not been paid yet into cash that your company can use right away. 

Companies that deal in high-cost products or services sold to customers and billing them by invoice. The payment terms for these invoices often have long pay times, up to one year in most cases. That means that these companies may not see payment for the value that they provided to customers for up to a year after they were billed. 

A/R invoices are treated as assets since another company or individual owes your company money. At some point, they will have to pay or face legal action. Either way, they end up paying in the end, essentially making these invoices as good as cash investments. 

A/R financing uses these unpaid invoices in several ways to get cash for the business. When either used as collateral for a loan or sold as assets to a lender, your company can get an influx of cash equal to up to the full value of those invoices. How much you get is determined by the value of the invoices and the method you use for your A/R financing.

A/R Financing a Loan

When you treat the unpaid A/R invoices as collateral, you can take out a loan with a fractional lender. The lender will give you a loan for the full value of the invoices, which you have to pay back with interest and possibly some fees depending on the agreement. 

The advantage of doing your A/R financing as a loan is that you still own those A/R invoices. Customers still have to pay you. Even more important, customers won’t feel like you sold them to another company since the lender cannot collect on those invoices.

However, the difficult part of this is that you get an influx of cash, but you have to pay back more than the invoices were worth. This is a method that should be saved for when you need to make a growth investment in the business. That way, your investment will yield results and you’ll make more than enough to repay the loan.  

A/R Financing as an Asset Sale

Another way to do A/R financing is as an asset sale. Unpaid A/R invoices are treated as assets, and your company can sell those assets to a lender. When this happens, you are selling the right to collect on those invoices to the lender in exchange for cash. 

In these cases, the lender will give you less than the full value of the invoices. One advantage of this is that you do not have to pay that money back. Instead, the lender will collect the payments from the invoices, which should be worth more than they paid for the assets if they collect all of the invoices. 

The biggest advantage of this method is that you can sell away the risk that a customer will not pay the invoice, even given the full year payment term. Instead, you sell the asset and get money immediately by sacrificing the right to collect the full value of the invoice later. 

The biggest downside to this is that you will receive less money overall for your invoices in exchange for quick cash. 

Why Your Business May Need Accounts Receivable Financing

Just like any other type of financing, accounts receivable financing lets you get cash upfront to help grow your small business. You can use the money to finance inventory, expand your operations, hire new employees, or complete renovations on your facility. You can also use A/R financing to cover operating costs such as utility bills and payroll. 

There are a few situations in which your business may need additional working capital and turn to A/R financing for help. Some examples include: 

Seasonal Businesses

If your business is seasonal, you may need more money to operate during off-peak times. Residential construction companies have this problem often. The winter months or the rainy summer months can make it difficult to get work done. People also stop wanting to work on their houses during these times, making work harder to come by. Fortunately, construction companies have long payment terms in their invoices. 

If business slows down and you need an influx of cash to pay staff and expenses, then selling some of these invoices is a good idea. You’ll get money to fund your business until it picks up again. 

Business The Need Investment Capital

If your company needs capital to make a big investment in the company so that it can take advantage of a new opportunity for growth, waiting until you save the money is not a good idea. Instead, use A/R financing to get the money that you need immediately so that you can buy the resources that you need to take advantage of that new opportunity. 

Manufacturers often have this issue where they could take on new contracts, but need to retool their facility first. A/R financing can provide the funds needed to retool immediately and not miss this new opportunity.

Things to Consider Before Committing to A/R Financing

While A/R financing can be an effective tool for business growth, it takes some preparation to use it effectively. Before you begin, consider a few things first.

Invoice Age

One of the biggest considerations is the age of the invoices that you want to sell or use as collateral. Older invoices that are closer to expiring are less desirable than new ones. This is because new invoices give companies time to go through the collections process. If the invoice expires, the only option is to take legal action to force a payment. Legal action is expensive, so financiers will set limits on how old invoices can be. 

Invoice Value

Financiers also want to take on higher value invoices. Dealing with smaller value invoices means a lot more work for less money on their part. When you prepare for A/R financing, consider invoices with larger value amounts to get more from the lender. 

Invoice Volume

Also consider how many invoices you want to use. A large volume of invoices will mean that you need a larger, more resource-rich lender who can handle a large number of invoices. Smaller lenders may not have the resources to devote to large volumes.

Tips for Using Accounts Receivable Financing to Your Advantage

Here are some tips to help you make the most of A/R financing:

Only Get As Much As You Need

Like with all forms of financing, you are deferring the effects of financing your business. If you take a loan, you have to pay that back. If you sell assets, you have to deal with the lost revenue. Whatever option you choose, there is a tradeoff.

The best way to avoid problems is to only get as much financing as you need. That way, you never put yourself in a position where you can’t afford the ramifications of your decisions. 

Shop Around

You can get quotes from multiple lenders to see what they offer. It is always a good idea to shop your invoice package around to see what lenders think it is worth.

Prepare a Thorough Proposal

Make a detailed proposal and include information on your sales projections, net worth, and cash flow. This will help you secure financing from lenders. Treat this process like you would courting an investor. You are, essentially, trying to get a lender to invest in your business by giving you a lot of money and taking away some of your risk. 

Build a Company That is Better At Customer Service

A/R financing is a useful tool for any small business that needs additional cash for development. Make sure that you are using that money to make your business better, including improving the customer experience. A big part of this is making sure that you always answer the phone. 

Use some of this money to hire an answering service. That way, you always have someone on the phone ready to talk to your customers and make them feel like they are the most important thing that your company focuses on every day. 

If you’re ready to get started with a professional answering service, we’re here to help. Contact Answer Aide by calling (866) 427-3500 or by filling out our online form. We’re happy to partner with you to support your business while it grows.

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