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Accounts Receivable Financing: What Is It and How Does It Work?

Accounts Receivable Financing is a type of financing that allows a business to obtain cash in advance based on its outstanding invoices. Accounts receivable are the amounts that customers owe to a business for the goods or services that they have purchased on credit. Accounts receivable are reported as current assets on the balance sheet, but they are not readily available as cash until they are collected.

Accounts receivable financing can help a business improve its cash flow, especially if it has long payment terms with its customers or faces delays in collecting payments. Accounts receivable financing can also help a business avoid the risk of bad debts, as the financing provider assumes the responsibility of collecting the invoices.

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Accounts receivable financing can be done in two main ways: factoring and asset-based lending.

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Factoring

Factoring is a form of accounts receivable financing where a business sells its invoices to a third-party company, called a factor, at a discount. The factor pays the business a percentage of the invoice value, usually between 70% to 90%, upfront. The factor then collects the full amount of the invoice from the customer and pays the remaining balance, minus fees and interest, to the business.

Factoring is considered a sale of assets, not a loan, so it does not create any debt or affect the credit rating of the business. However, factoring can be expensive, as the factor charges fees and interest based on the invoice value, not the amount advanced. Factoring can also affect the relationship between the business and its customers, as the factor takes over the collection process and may use different methods or terms.

There are two types of factoring: recourse and non-recourse. In recourse factoring, the business is liable for any invoices that are not paid by the customers within a certain period. In non-recourse factoring, the factor assumes the risk of non-payment and cannot claim any recourse from the business.

Asset-Based Lending

Asset-based lending is another form of accounts receivable financing where a business uses its invoices as collateral for a revolving line of credit from a lender. The lender evaluates the quality and value of the invoices and advances a percentage of their value, usually between 70% to 85%, to the business. The business can draw funds from the line of credit as needed, up to the limit set by the lender. The business pays interest only on the amount drawn, not on the entire line of credit.

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Asset-based lending is considered a loan, not a sale of assets, so it creates debt and affects the credit rating of the business. However, asset-based lending can be cheaper than factoring, as the interest rate is based on the amount advanced, not on the invoice value. Asset-based lending also allows the business to retain control over its collection process and relationship with its customers.

There are two types of asset-based lending: notification and non-notification. In notification asset-based lending, the customers are notified that their invoices have been assigned to the lender and are required to make payments directly to the lender. In non-notification asset-based lending, the customers are not notified that their invoices have been assigned to the lender and continue to make payments to the business, which then forwards them to the lender.

Receivable financing is a type of financing where a business sells its accounts receivable to a third party (known as a factor) at a discount. The factor then collects the full amount of the receivables from the customers. This type of financing can be a good option for businesses that need cash quickly and don’t want to wait to collect their receivables. However, it can also be expensive, as the factor will charge a fee for the service.

Payable financing is a type of financing where a business borrows money to pay its suppliers. This type of financing can be a good option for businesses that need to cover short-term expenses, such as inventory or payroll. However, it can also be expensive, as the lender will charge interest on the loan.

Here is a table that summarizes the key differences between receivable financing and payable financing:

Feature Receivable Financing Payable Financing
Type of financing Selling accounts receivable Borrowing money
Purpose Get cash quickly Cover short-term expenses
Fees Factoring fee Interest
Risk Accounts receivable may not be collected Loan may not be repaid
Benefits Quick access to cash No risk of non-payment
Drawbacks Expensive Can be difficult to qualify for

 

What is the difference between receivables and accounts receivable?

Receivables is a broader term that refers to all of the money that a business is owed by its customers. This includes both accounts receivable and other types of receivables, such as notes receivable and interest receivable.

Accounts receivable is a more specific term that refers to the money that a business is owed by its customers for goods or services that have already been delivered or provided. Accounts receivable are typically the largest component of receivables for most businesses.

Here is a table that summarizes the key differences between receivables and accounts receivable:

Feature Receivables Accounts Receivable
Type of asset Current asset Current asset
Definition All money that a business is owed by its customers Money that a business is owed by its customers for goods or services that have already been delivered or provided
Examples Accounts receivable, notes receivable, interest receivable Accounts receivable
Location on balance sheet Current assets section Current assets section
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