Accounts receivable financing, often referred to as factoring, is one of the world’s oldest means of financing. While it may not be the newest or flashiest way to get cash, it has become more popular in recent years because it can be so beneficial for small business owners who have been rejected for traditional loans.
With accounts receivable lending, you receive money from a lender in exchange for the money owed to you from unpaid invoices. The unique arrangement makes this type of financing less of a loan and more of the sale of an asset. You’ll get a percentage of the receivables in advance, then the lender will pursue the businesses that owe the money. Once they’ve collected the receivables, the lender takes their cut of the money and pays you the balance.
An obvious benefit of accounts receivable lending is that you can absolve yourself of the stress related to tracking down payments. So if you have unpaid invoices piling up and find yourself short on cash, the tradeoff can be a lifesaver.
Understanding Accounts Receivable Advance Rates
Every situation has its unique considerations, but you can plan on receiving as much as 80% of the total value of your unpaid invoices. The money will become available in as little as 72 hours, with the factor rates starting at 5%.
There are 4 main types of accounts receivable lending:
- Accounts Receivable (aka Factoring): With this financing, you sell your purchase orders or accounts receivables in exchange for quick cash. You’ll also receive a portion of the money collected.
- Purchase Order Financing: You secure these loans with either a purchase order or a contract, which pays for inputs needed to produce and ship a product or to deliver a service.
- Inventory Financing: This asset-based lending allows your business to get a revolving line of credit by using your inventory for collateral.
- Single Invoice Factoring: By advancing the payment of a customer’s purchases, you can acquire money in the short-term with this helpful form of business financing.
Here’s a quick case study for illustrative purposes. A small business in San Diego has $100,000 in receivables. They apply for accounts receivable lending and qualify for 75% of the value of the invoices. The reason that percentage wasn’t 80% was that some of the receivables were fairly old and the lender was doubtful they would be able to collect on all of them.
With the lender holding the invoices, the business gets the up-front payment they had agreed upon. The lender then begins to pursue those who owe you money, giving the small business the lion’s share of everything collected (the lender will first take their fee from this amount).
Ultimately, the lender can collect on nearly all the receivables. The small business has been spared the tedious process of tracking down the money and still gets a sizeable amount of financing via the lender. With that influx of cash, the business has the funds necessary to endure an unusually slow winter season and prepare for the influx of tourists predicted for the coming summer months.
Is Accounts Receivable Lending Right For You?
It’s usually not difficult to obtain accounts receivable lending, as the qualification standards are lower than you might find with many traditional loans. A big part of this is because the lender will be getting something of value from the get-go, lowering their risk. They may have to work hard to collect the money tied up in receivables, but at least they’ll be in control of the situation.
Another reason for the more lenient approvals is that your business’s credit score and financial history will not be as heavily scrutinized. Remember—you won’t be responsible for paying any of the money. So if you missed a handful of rent payments in 2016 or accidentally wrote some bad checks in 2017, the lender might not even notice. They’ll be more focused on the financial health of the businesses they’re looking to collect from.
This lack of lender scrutiny is characteristic of most financing products in the cash flow family of loans, which includes accounts receivable lending, merchant cash advances, and business lines of credit. As long as your business has been running for at least 1 year, brings in $50,000 or more a year, has performed well in the recent past, and is on an upward trajectory, you should be a solid candidate. To start forming an accurate view of these factors, the lender will probably request your bank statements or receivables from the past 4–6 months.
Because cash flow loans are secured with future money, you won’t need to put your present-day assets up as collateral. Perhaps this doesn’t sound like a big deal. But it can definitely make people feel squeamish when they have to risk beloved possessions, such as a boat or even their home, on the altar of financing. Cash flow loans let you keep all your precious possessions safely in your possession.
Accounts receivable lending could be a good remedy if you find yourself in a situation where you need money fast. Perhaps you’ve got a big project coming and need additional funds, or you’ve encountered a new business opportunity that’s too good to pass up, or you simply lack the time and resources to pursue your growing collection of unpaid invoices.
“Cash flow loans address short-term liquidity issues and as such are paid back quickly, with frequent payments,” says Joyce Walsack, a financial expert with the US Chamber of Commerce. “As money comes into the business, some of it is paid out to the lender, as often as daily.”
What matters is that with accounts receivable lending, you can connect with fast cash. From the expedited application to the lenient approval process, this financing offers you one of the most streamlined processes on the market.