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.
Key Points
• Accounts receivable (AR) financing gives businesses access to quick capital based on the value of their accounts receivables.
• With AR financing, you use your outstanding invoices as collateral for a loan or line of credit, or you sell them to a third party.
• This type of financing can benefit businesses with cash flow gaps due to delayed customer payments, providing funds without waiting for receivables to clear.
• Different types of accounts receivable financing include asset-based lending, traditional factoring, and selective receivables finance — each with unique structures and implications.
• Approval is based on the creditworthiness of clients rather than the business itself, which can make it easier to qualify for than traditional funding.
What Is Accounts Receivable Financing?
For businesses that issue invoices to clients, accounts receivable financing (also known as invoice financing) is a way to get an advance on the balances owed on those invoices, minus fees.
What Is Accounts Receivable?
Accounts receivable is a term that refers to money that your customers owe you. This differs from accounts payable, which refers to bills from vendors you need to pay. Whether you use cash or accrual accounting, accounts receivable is listed on the balance sheet as an asset, since it’s money that is owed to the company.
Accounts receivable financing is a type of small business 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 or line of credit.
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, lenders typically want you to have certain credit scores, time in business, and revenues. With AR financing, on the other hand, the lender approves the funding and loan amount by reviewing your clients’ payment history, weighing their creditworthiness more heavily than your own. As a result, this can be a good funding option for small businesses with a limited or poor credit history.
In general, 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 invoices. The advance may be structured as an asset sale (called factoring) or as an invoice-backed loan or line of credit. How it works from here will depend on the type of AR financing you choose.
Types of Receivables Finance
There are actually three different types of accounts receivable financing, 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. With asset-based invoice financing, you use your accounts receivables as collateral to get a loan or line of credit from an invoice financing company. You’ll pay interest on the amount you borrow and retain ownership of the invoices. However, you must repay the loan based on the agreed terms, regardless of whether your customers fully pay their invoices.
Traditional Factoring
With invoice factoring, you sell your accounts receivables to a factoring company. The company will typically give you less than the invoice value (often 70% to 90%) up front. They are then responsible for collecting on the invoices directly from your customers. Once your customers pay, the company will take out fees and forward you the balance.
One advantage of factoring is that you won’t have to chase down payment from your customers. However, factoring tends to cost more than asset-based invoice financing, since the factoring company does more work to collect payments. Also keep in mind that having a third party interact with your clients could damage your business relationships.
Selective Receivables Finance
With traditional invoice financing, you typically upload all outstanding invoices and get an advance based on that number. With selective receivables financing, on the other hand, you can pick and choose which invoices you want to use for financing.
For example, maybe you know that one client, who has a $7,500 monthly retainer, pays a little late but is still reliable in paying. That might be the receivable you want to use for financing, since you’re confident the invoice will get paid.
Financing rates for selective receivables financing are typically lower than other types of invoice financing, due to the high quality of the receivables. In addition, this type of financing can sometimes be structured so it won’t show up on your company’s balance sheet — or impact your ability to qualify for other types of business financing.
Pros and Cons of Accounts Receivable Financing
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 | Cons |
|---|---|
| Provides quick access to funds | Higher cost than many other small business financing products |
| Easier to qualify for than traditional business financing | With factoring, your customers will be contacted by a third party |
| Improves cash flow | With asset-based invoice financing, you’re depending on customer payments |
| With factoring, you don’t have to chase down payments | Limited to businesses with outstanding invoices |
Pros
The process of securing invoice financing is typically faster than traditional loans. This speed can be critical for small businesses that need quick capital. It’s also generally easier to qualify for invoice financing, since approval is based on the creditworthiness of the clients who owe the invoices, rather than the business itself.
Accounts receivable financing can also improve your company’s cash flow, allowing you to invest in improvements, pay suppliers, and promote business growth before customers pay balances fully. And in the case of factoring, it also allows you to completely wash your hands of the stress of getting clients to pay invoices.
Cons
On the downside, the cost of accounts receivable financing is typically higher compared to more 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.
This type of financing is also limited in scope, since it only applies to businesses with outstanding invoices. Companies with cash sales or advance payments may not benefit from this financing model.
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The Takeaway
Accounts receivable financing is a way for businesses to access cash by using their unpaid customer invoices as collateral for a loan or by selling them to a factoring company.
This type of financing could be useful if you experience cash flow gaps due to delayed customer payments, as it allows you to maintain steady operations without waiting for receivables to clear. But there are some downsides involved, including costs. Before you jump into AR financing, it’s a good idea to weigh the pros and cons and compare it to other funding options that may be available to your small business.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is the difference between factoring and accounts receivable financing?
Factoring and accounts receivable (AR) financing are both ways to access funds based on outstanding invoices, but they differ in structure. Factoring involves selling invoices to a third-party company at a discount; this company then collects directly from customers. In AR financing, the business retains ownership of the invoices and borrows against them, using the invoices as collateral. While factoring is typically faster and offloads collections, AR financing allows the business to maintain control over client payments and customer experience.
Is a loan considered accounts receivable financing?
A loan is different from accounts receivable financing. With a traditional loan, a business borrows a lump sum from a lender and repays it with interest over time, regardless of invoices. With accounts receivable financing, a business accesses funds by borrowing against their unpaid invoices, using them as collateral.
What is an example of an account receivable?
An account receivable is money owed to a business by a customer for goods or services provided but not yet paid for. For example, a consulting firm might complete a project for a client and issue an invoice for $3,000, giving the client 30 days to pay. Until the payment is received, this $3,000 invoice is considered an account receivable for the consulting firm. The receivable will appear as an asset on the firm’s balance sheet, since the customer is legally obligated to pay the debt and the company expects to collect it.
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