Can I Borrow Against Accounts Receivable?

Accounts receivable (AR) represent the outstanding invoices a business has issued to its customers but has not yet collected. Essentially, they are sales made on credit, reflecting money owed to the business. For many companies, especially small to medium-sized enterprises, waiting for these receivables to be paid can create cash flow challenges, making it difficult to cover operational expenses or invest in growth opportunities.

Borrowing against accounts receivable, also known as accounts receivable financing or invoice financing, offers a solution to this common problem. This financing method allows businesses to leverage their unpaid invoices to secure immediate funding. By doing so, they can improve cash flow, meet their financial obligations, and seize new business opportunities without waiting for customers to pay their invoices.

What Does It Mean to Borrow Against Accounts Receivable?

Borrowing against accounts receivable, also known as AR financing or invoice financing, involves using a business’s outstanding invoices as collateral to obtain immediate funding. This type of financing allows businesses to convert their receivables into cash without waiting for their customers to pay. It’s a useful strategy for managing cash flow, covering operational expenses, and investing in growth opportunities.

The process of borrowing against accounts receivable typically involves the following steps:

1. Choose a Financing Partner: The business selects a lender or financing company specializing in AR financing.
2. Submit Invoices: The business submits its outstanding invoices to the financing company for review.
3. Advance Payment: Upon approval, the financing company advances a percentage of the invoice value, typically ranging from 70% to 90%.
4. Collection: The financing company takes over the responsibility of collecting payments from the business’s customers.
5. Final Payment: Once the customer pays the invoice, the financing company releases the remaining balance to the business minus a financing fee.

For example, if a business has an invoice worth $100,000 and the financing company offers an 85% advance, the business would receive $85,000 upfront. When the customer pays the invoice, the financing company deducts its fee and remits the remaining balance to the business. This method provides quick access to cash, helping businesses maintain liquidity and manage their finances more effectively.

Benefits of Borrowing Against Accounts Receivable

The benefits of borrowing against your accounts receivables include:

• Improved Cash Flow: One of the primary benefits of borrowing against accounts receivable is the immediate improvement in cash flow. Instead of waiting 30, 60, or even 90 days for customers to pay their invoices, businesses can access funds almost immediately. This quick infusion of cash helps businesses meet their short-term financial obligations, such as payroll, rent, and inventory purchases, without disrupting operations.
• Flexibility and Speed: AR financing offers significant flexibility and speed compared to traditional financing methods. The approval process for borrowing against accounts receivable is typically faster and less stringent, as lenders focus on the creditworthiness of the invoiced customers rather than the business itself. This means that businesses with less-than-perfect credit can still access funding.
• No Need for Additional Collateral: Unlike traditional loans that often require substantial collateral, such as real estate or other significant assets, AR financing uses the business’s invoices as collateral. This reduces the need for additional security, making it an accessible option for businesses that may not have valuable assets to pledge.

Risks and Considerations

Key risks and potential considerations when borrowing against accounts receivables include:

• Potential High Costs: One of the main risks associated with borrowing against accounts receivable is the potential for high costs. Factoring fees can range from 1% to 5% of the invoice value per month, which can add up quickly, especially for businesses with a high volume of invoices. These fees are higher than traditional loan interest rates, making AR financing a more expensive option in the long run.
• Impact on Customer Relationships: Using a factoring company means that the responsibility for collecting payments shifts from the business to the lender. This change can affect customer relationships, as customers will now interact with a third party for payment issues. Some customers may perceive this as a sign of financial instability, which could impact their trust and confidence in the business.
• Dependence on Accounts Receivable: AR financing is heavily dependent on the quality and reliability of a business’s receivables. If the business has customers with poor credit or a history of late payments, it may face challenges securing favorable terms or even approval for financing.

How to Qualify for Accounts Receivable Financing

To qualify for accounts receivable (AR) financing, businesses typically need to meet several key criteria:

• Business History: Most lenders prefer businesses with at least six months to a year of operational history and a track record of generating consistent revenue.
• Creditworthy Customers: The creditworthiness of a business’s customers is crucial since the financing company relies on these customers to pay their invoices. Strong customer credit profiles can enhance eligibility and terms.
• Invoice Quality: Invoices should be clear, accurate, and free of disputes or contingencies. They should reflect legitimate sales to creditworthy customers.
• Industry: Some lenders specialize in specific industries, so businesses in those sectors may find it easier to qualify.

To apply for AR financing, businesses need to provide certain documentation to the financing company:

• Financial Statements: Recent balance sheets, income statements, and cash flow statements to demonstrate the business’s financial health.
• Accounts Receivable Aging Report: A detailed report showing outstanding invoices and the duration they’ve been unpaid.
• Invoices: Copies of the invoices that the business wants to factor.
• Customer Information: Credit information and contact details for the customers whose invoices are being factored.
• Business Information: Basic business details, such as the business name, address, and tax identification number.

The steps business owners should take to apply for AR financing are:

1. Research and Select a Financing Company: Identify reputable AR financing companies that specialize in your industry and offer favorable terms.
2. Prepare Documentation: Gather all required financial statements, invoices, customer information, and other necessary documentation.
3. Submit Application: Complete the application form provided by the financing company and submit it along with the required documentation. Ensure all information is accurate and complete to expedite the review process.
4. Underwriting and Approval: The financing company will review the application, focusing on the creditworthiness of your customers and the quality of the invoices. They may request additional information or clarification during this process.
5. Receive an Offer: If approved, the financing company will present an offer outlining the advance rate, fees, and terms of the financing agreement.
6. Review and Sign Agreement: Carefully review the offer’s terms and conditions. If acceptable, sign the agreement to proceed.
7. Receive Funding: Once the agreement is signed, the financing company will advance the agreed-upon percentage of the invoice value, typically within a few days.

Types of Accounts Receivable Financing

Factoring is a type of accounts receivable financing where a business sells its outstanding invoices to a factoring company at a discount. The factoring company advances a portion of the invoice value, typically between 70% and 90%, to the business immediately. The factoring company then takes over the responsibility of collecting payments from the business’s customers. Once the customers pay their invoices, the factoring company remits the remaining balance to the business, minus a factoring fee. Factoring can be either recourse or non-recourse. In recourse factoring, the business retains the risk of non-payment, while in non-recourse factoring, the factoring company assumes the risk.

Asset-based lending (ABL) involves securing a loan using the business’s accounts receivable, inventory, and other assets as collateral. Unlike factoring, where the business sells its invoices, ABL allows the business to retain ownership and control of its receivables. The lender provides a line of credit based on a percentage of the value of the receivables and other collateral. As the business collects payments from customers, it repays the loan, and the line of credit is replenished. ABL provides more flexibility and is often used for larger financing needs.

When comparing factoring to asset-based lending, it’s important to consider the following:

Choosing between factoring and asset-based lending depends on the business’s specific needs, the desired level of control over receivables, and the overall cost considerations. Both options can provide valuable financing solutions to improve cash flow and support business growth.

Conclusion

Borrowing against accounts receivable through methods like factoring and asset-based lending offers businesses a valuable solution for improving cash flow and maintaining financial stability. By leveraging outstanding invoices, businesses can quickly access funds without waiting for customer payments. This financing approach provides flexibility, reduces the need for additional collateral, and helps manage operational expenses effectively.

While AR financing comes with considerations such as potential high costs and the impact on customer relationships, its benefits can significantly outweigh the drawbacks for many businesses. Careful evaluation and choosing the right type of financing can help businesses capitalize on growth opportunities and maintain smooth operations.

Explore the A/R factoring and ABL options your company qualifies for by completing our digital application!