The Basics of Accounts Receivable Financing
When a business needs immediate cash flow but doesn’t want to go into debt with a traditional loan, accounts receivable financing is a viable alternative to consider. With this method of financing, a business can get a cash advance based on sales it has already made and invoiced.
Understanding How it Works
When a company issues invoices, there’s usually a lag time before customers pay their bills. This lag time decreases the company’s cash flow as it waits for accounts receivable to be paid up. With accounts receivable financing, however, the company can sell those invoices to a special company called a factor, for a fee, and in exchange receive a percentage of the cash due before the customers actually pay their invoices.
The factor charges a fee for this service. This usually amounts to a percentage of the overall amount to be collected on the invoices. In the meantime, the factor pays the company a percentage of the total amount due on the invoices. Generally speaking the initial cash advance amount averages between 75% to 85%.
Immediate Cash Flow
With this cash, a company can move forward with purchases or expenses it urgently needs to cover, but didn’t otherwise have the money for. In accounts receivable financing, a business owner gains access to liquidity and doesn’t have to go into debt, because this financing isn’t a loan.
After the factor purchases the invoices, it takes up all the administration involved in collecting payment from customers. That gives the business even more flexibility by allowing it to focus on more important matters. Once the invoice is paid, the factor releases the remaining percentage of cash to the company.
Particularly Helpful for New Businesses
A factoring company doesn’t use a business owner’s personal credit score to determine whether or not to advance the cash. This can be especially helpful for new businesses that don’t have a credit score, or for business owners who have a poor credit rating.
Since ultimately the factoring company is going to be collecting the money from the customers who have been invoiced, it looks at how creditworthy those customers are. If it determines that those who have been invoiced are likely to pay their bills, it will advance the cash. After all, the risk for the lender lies in whether or not the invoiced customers are going to settle up.
Accounts receivable financing is a great way for businesses to improve their cash flow without going into debt. By selling their invoices, they can get a cash advance and begin investing immediately in what they need to grow their business.