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Accounts Receivable Loan Financing
Accounts receivable financing is a form of asset financing wherein a company uses the money they are owed by their customers, or receivables, as collateral for a loan. The amount of money received is equivalent to a reduced amount of the receivables pledged to the loan and is typically determined by the age of the receivables involved.
Accounts receivable financing is oftentimes called factoring, invoice factoring, invoice financing, or receivables financing and is an extremely effective method for raising working capital. This is especially true for businesses that don’t conform to the more traditional lending standards such as:
- businesses with bad, little, or no credit
- businesses with marginal revenues and that do not have the financial means to make the regular monthly payments of a traditional loan
- Businesses with open purchase orders and do not have the cash flow or working capital to start new projects until these past invoices are paid.
Furthermore, accounts receivable loans are a relatively simple transaction compared to other types of financing. Once an invoice has been generated the business can sell it in order to access immediate cash. In most cases, a company will allow their customers up to 60 days to pay off their invoices thereby extending credit to them for that 2-month period. However, accounts receivable financing enables you to have the money from those invoices right now without enduring the wait.
How does A/R Financing work?
The company providing the A/R financing, known as a “factor”, purchases the accounts receivable at an average of 80% of the amount of the invoice, while the 20% that remains is held as a reserve until the invoice has been cleared. When the customer pays the invoice, the factor remits payment (plus the reserve) to the company less the amount of the advance and all applicable fees which may include interest and a service charge. These are based on how long the factor has to wait for payment from you or your customer.
The factor typically resubmits the invoice to the customer after purchasing it and lists their address as the new one to submit payment to. They will either explain this to the customer or they will re-invoice them using the original company’s letterhead. The invoices are now owned by the factor, which has the first claim to any and all money generated by the payment of that invoice. Should customers miss deadlines; factors will provide collection services if and when required. This helps you to avoid additional expenses, thereby benefiting your company’s cash flow.
When you use accounts receivable financing to obtain working capital, you benefit in the following ways:
- A/R financing is not so much a loan as it is an advance against cash you will eventually receive. So there are no monthly loan payments to stress over.
- These loans (advances) do not rely on your business or personal credit history. Instead, they are based on the strength of the customer’s willingness to pay.
- You can immediately invest that working capital into your company to fulfill other orders and generate more business.