Accounts Receivable Financing

MoneyBestPal Team
A way for businesses to get cash quickly by using their unpaid invoices as collateral.

Accounts receivable financing is a way for businesses to get cash quickly by using their unpaid invoices as collateral. It can assist organizations in resolving cash flow issues, particularly when their clients take a while to pay or have irregular payment schedules.

There are various forms of accounts receivable financing, each with advantages and disadvantages of its own. We will define accounts receivable finance, describe how it operates, and outline the key alternatives available to businesses.

What is accounts receivable financing?

Accounts receivable finance is a type of short-term financing that enables firms to borrow money against the value of their accounts receivable, which are the sums owed by their clients for goods or services delivered. The balance sheet classifies accounts receivable as an asset, but until they are paid, they are not liquid. If a company needs quick access to funds to pay bills, engage in expansion, or seize opportunities, accounts receivable financing may be able to help.

How do accounts receivable financing work?

The way accounts receivable financing operates is by giving a third-party financier, like a bank, factoring firm, or issuer of asset-backed securities, ownership or risk of the receivables from the business. A percentage of the invoices' face value, often between 70% and 90%, is paid to the company by the financier in exchange for a fee or interest. When the invoices are paid in full, the remaining amount—known as the reserve—is paid to the company, less any further fees or charges.

The business may keep or lose control over the procedure for collecting debts from customers and managing customer relationships depending on the type of accounts receivable financing used. Depending on whether the financing has recourse or is non-recourse, the company may also be responsible or not for any unpaid invoices.

What are the main types of accounts receivable financing?

There are three main types of accounts receivable financing: accounts receivable loans, factoring, and asset-backed securities.
  • Accounts receivable loans: Accounts receivable loans are loans secured by accounts receivable as collateral. The company pays interest on a loan that it receives from a bank or another lender for a portion of the invoice value. The company is still in charge of its bills, collects payment on them, and is liable for any unpaid balances. Accounts receivable loans might be less expensive than other types of financing, but they still demand a solid track record of financial stability from the company.
  • Factoring: Factoring is the discounted selling of accounts receivable to a factoring business. A portion of the invoice value is paid to the business in advance by the factoring company, which then collects the entire amount from the customers. The factoring company manages the collecting procedure and accepts the risk of non-payment. For businesses with bad credit or weak finances, factoring can offer quick and simple access to cash. Nevertheless, it can be more expensive than other forms of financing and may harm a business' connection with its clients.
  • Asset-backed securities: Asset-backed securities are financial products that are supported by a collection of assets, such as accounts receivable. A special purpose vehicle (SPV) purchases all or a portion of the invoices from the company and offers securities to investors. Customers make payments to the SPV, which then distributes those funds as coupon payments to investors. Under the SPV, the business transfers ownership and risk of its invoices to investors while still receiving funding from them. Asset-backed securities, however often complex and expensive to set up and administer, can provide substantial funding for companies with a diverse portfolio of high-quality invoices.