App version: 0.1.0

Accounts Receivable Financing Need to Knows

What Is Accounts Receivable Financing?
Susan Guillory

Susan Guillory

Updated February 19, 2022
Share this article:
Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Customers don’t always pay their bills on time. And even when they do, a 30, 60, or 90 day repayment term can put a strain on your company’s cash flow. In the meantime, you have your own bills to pay. So, what can you do when outflows exceed inflows?One option is accounts receivable financing. With accounts receivable (AR) financing, you use your outstanding invoices to receive quick access to capital, either by selling those invoices or by using them as collateral to receive a loan.Unlike many types of business loans, AR financing usually doesn’t require a minimum credit score, revenue, or years in business. However, there are some tradeoffs involved. Here’s what you need to know about accounts receivable financing.

What Is Accounts Receivable Financing?

For businesses that issue invoices to clients, accounts receivable financing is a way to get an advance on the balances owed on those invoices, minus fees.

What Is Accounts Receivable?

In your business, you have two accounting terms you should be familiar with: accounts payable and accounts receivable.While accounts payable refers to bills from vendors you need to pay, accounts receivable refers to money that your customers owe you. Whether you use cash vs accrual accounting, accounts receivable is listed on the balance sheet as an asset, since it’s essentially money that is owed to the company.Accounts receivable financing is financing that is based on the value of your accounts receivable. In some cases AR financing involves selling those invoices at a discount. In other cases, you use the invoices as collateral for loan, line or credit, or cash advance. Essentially, AR financing allows you to use capital that would otherwise be unusable until your customers settle their invoices.

How Does AR Financing Work?

When you apply for a business loan, a lot of lenders want you to have certain credit scores, time in business, and revenues. However, some businesses simply can’t meet those requirements. Because accounts receivable financing typically only looks at your unpaid invoices as a way to determine whether to lend to you, it may be easier to qualify for this option.The process looks like this: You apply for financing through an AR lender and submit your outstanding invoices. Once approved, you’ll be advanced an amount, typically less than the full amount of the invoice.Accounts receivable financing can be structured as an asset sale (called factoring) or as an invoice-backed loan, line of credit, or advance.

Types of Receivables Finance

There are actually three different types of accounts receivable financing to consider, and each works slightly differently. Here’s a closer look.

Asset-Based Lending (ABL)

With asset-based lending, you use an asset as collateral to receive financing, even if you wouldn’t qualify for other types of loans.With accounts receivable lending, also called invoice financing, you use your accounts receivables as collateral to get a loan or cash advance from an invoice financing company. The invoice financing company may advance you 100% of an accounts receivable balance. You must then repay the balance over time, usually with interest and fees.With accounts receivable lending, you still own the receivables, and are responsible for collecting from your debtors.

Traditional Factoring

Factoring is the most common form of invoice financing for smaller businesses. With accounts receivable factoring, you sell your receivables to a factoring company. The factoring company will typically give you less than the invoice value, since there is some risk for the company that the invoice won’t get paid. Since it is an outright sale of receivables, you are no longer responsible for the collection process; these amounts are collected by the factoring company. Factoring can be more expensive than other types of invoice financing, since you won’t get the full amount of your invoices, but you won’t have to chase down payment from your customers.

Selective Receivables Finance

With traditional accounts receivable financing, you may upload all outstanding invoices and get an advance based on that number. With selective receivables financing, however, you can pick and choose which invoices you want to use for financing.Maybe you know that one client, who has a $7,500 monthly retainer, pays late but is still reliable in paying. That might be the receivable you want to use for financing, since you know the invoice will get paid.With selective receivables finance, you can typically secure advanced payment for nearly the full amount of each receivable (often around 85%). When the end customer pays the invoices, the financing company will send the remainder of the total invoice amount less fees and charges. Financing rates are typically lower than other types of accounts receivable financing. Also, this method may not count as debt on your balance, nor impact the market value of your business.
Is accounts receivable financing a good option for your business? Here’s a look at the overall benefits and drawbacks of this type of funding.

Pros

If you aren’t able to qualify for traditional financing, or you need cash quickly, accounts receivable financing could be a fast and easy way to get the capital you’re looking for. In the case of factoring, you completely wash your hands of the stress of getting clients to pay invoices. And with selective receivables financing, the money you borrow won’t show up as debt and, therefore, won’t impact your ability to get other financing.

Cons

The biggest drawback to accounts receivable financing is that when you compare small business loan rates, you may find that costs are higher than they are with traditional types of business financing, such as a term loan from a bank.And, if you go with AR factoring, you will lose control over communication with your clients. If you go with AR lending, on the other hand, you’ll still be on the hook for getting your clients to pay their invoices, or you may have to pay your debt out of pocket.

The Takeaway

Accounts receivable financing allows companies to get instant access to cash without jumping through hoops or dealing with long waits often associated with getting a business loan. Accounts receivable financing deals are usually structured as either asset sales (factoring) or loans (financing).If you use factoring, you don’t have to worry about repayment schedules. If you use financing, you may be able to obtain nearly the full value of your outstanding invoices immediately. On the downside, AR financing tends to cost more than traditional financing options. However, if your business has thin or poor credit, or you need to solve a cash flow deficit quickly, the fees may be worth it.

Small Business Loan Tips

  1. Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders.
  2. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
  3. If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Photo credit: iStock/shapecharge

Frequently Asked Questions

What is the difference between factoring and accounts receivable financing?
Is a loan considered accounts receivable financing?
What is an example of an accounts receivable?

About the Author

Susan Guillory

Susan Guillory

Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.
Share this article: