Accounting Receivable Financing – what exactly does that mean?
Selling your accounts receivable in exchange for a working capital loan is known as accounts receivable financing. Receivables are one of the best forms of collateral for loans because they are considered a highly liquid asset. When receivables are used as collateral, they can be worth up to 90% of their face value, so the loan amount is less than that. Customer payments should be sent to the lender, who will hold onto them. The difference between the cash received from collecting receivables and the amount loaned to the company is what the lender makes money on. Receivable default risks are transferred to lenders since they are purchasing receivables. The lender may only accept receivables from larger and more creditworthy customers of the borrower because of this risk.
Accounts Receivable are a type of debt
A company’s accounts receivable balance is made up of the unpaid invoices it has issued to its customers. Trade receivables are invoices that have not yet been paid. It is common for these invoices to be paid within 30 days of the invoice date, which makes them one of the company’s most liquid assets. Since receivables can be easily converted into cash, they are considered one of the most valuable assets that lenders have access to. Accounting receivable financing is a viable option for a company with a substantial amount of current accounts receivable.
Accounts Receivable Financing: When to Use It
The interest rate associated with this type of financing is quite high because of the high level of paperwork involved and the risk of customer defaults. Because of this, it is typically used only by businesses that are unable to secure lower-cost financing options. When a company has little cash on hand and is growing quickly, accounts receivable financing is a great option for them because they don’t have the money to pay for the inventory they need to keep up with the demand for their products.
When invoice terms are long, receivable financing can be a good option. This can happen if a customer (often a large retail chain) forces a start-up company to accept payment terms that range from 60 to 120 days. If the company has limited financing, it must support long receivable terms at the same time. An account receivable financing arrangement allows a lender to make immediate payment to the company in this situation.
The Price of Funding Receivables
One of the more expensive forms of financing is the financing of accounts receivable. Its price is influenced by a number of variables. An upfront fee is charged to cover the costs of underwriting and origination. Depending on the size and complexity of the proposed arrangement, this fee may go up significantly. The upfront fee can also be charged again if the arrangement is for one-time financing rather than a long-term arrangement. In addition, every time a customer pays an invoice, the company must pay a processing fee. In most cases, the fee is calculated as a percentage of the invoice’s total amount. Financing costs can be reduced if the invoices are of high quality and easy to collect. It’s common for lenders to offer a variety of interest rates in order to attract a variety of customers. Shopping around will help you find the best rate structure for your specific needs.
An Illustration of Financing for Receivables
As an example, a shoe store chain purchases $50,000 worth of shoes from a shoe manufacturer. Net 90 terms are required by the chain from the manufacturer. Until the shoe store chain pays $50,000, the $50,000 is part of the manufacturer’s receivables for the next 90 days.. In exchange for a 90% cash advance, the manufacturer transfers the invoice to a financing company, resulting in a cash payment of $45,000 immediately. After ninety days, the lending company has collected $50,000 from the shoe chain and made a profit of $5,000.
Aspects to Consider When Getting a Loan
With an accounts receivable financing deal, a borrower will receive a certain amount of cash depending on how well-qualified its customers are and how old their outstanding accounts are. Lenders are more willing to pay a large portion of the face value of invoices issued to large, financially stable customers. Lenders are more likely to lend money if the borrower’s invoices have not yet been paid. Older invoices issued to customers with lower credit ratings will only receive a small percentage of the invoice’s total value in financing.
Benefits of Financing Receivables
Accounts receivable financing has two major advantages. First and foremost, it provides a business with immediate access to funds without having to wait for the paperwork approvals that are typically associated with most business loans. With receivable financing, you can get a loan in a few weeks rather than a few months as with traditional bank financing.
A second benefit of selling receivables is that the borrower no longer has to worry about collecting the money owed to them, as the party who bought the receivables will take care of that. Allows it to reduce its collection staff to handle only those receivables that have not been sold off. It’s still possible that the borrower will still be responsible for collecting from customers who are less reliable.
Accounts Receivable Financing Disadvantages
Due to the fact that their payments must be sent to a different address, clients who use receivable financing run the risk of informing their clients about the arrangement in place. In order to alleviate this problem, you can describe the payments as going to a lockbox for cash management purposes. Although the arrangement may appear to indicate that the company is in financial trouble, it does not necessarily mean that this is the case.
An additional problem is that these arrangements charge high-interest rates, which can have a negative effect on cash flow and reported profits for the borrower. It’s possible that adding the cost of accounts receivable financing will result in losses for a company with low-profit margins, forcing it to close shop.
When many customers default on their payments, lenders may suddenly stop providing additional financing. As a result, the borrower may have to default on its debts because it does not have enough time to secure new financing.
Accounts Receivable Financing: A Guide for Prospective Clients
Many steps must be taken in order to get accounts receivable financing. The first step is to figure out how much money you’ll need in the next few months. Next, take a look at your list of outstanding invoices and remove any that have a low chance of being paid. There are still a few invoices that lenders will review. Gather the company’s most recent bank statements and tax returns, along with a business license, tax identification number, and articles of incorporation. You can expect lenders to use this information in their credit evaluations. A credit report will also be run on the company. These document submissions may be made via the internet, after which lenders typically take a few weeks to review the information and decide whether to enter into a lending agreement. Funding can be set up within a few days of approval.