What Is Accounts Receivable Financing?
Accounts receivable financing allows businesses to use their unpaid invoices as collateral for borrowing. It can be a saving grace for business owners who need quick access to cash for investing in new equipment, taking on new projects, or simply covering day-to-day expenses.
This article covers everything from the basics of accounts receivable (AR) financing to the best AR companies your business can borrow from.
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How does accounts receivable financing work?
Accounts receivable financing is a type of loan where a company’s unpaid invoices — accounts receivable — act as collateral. With an accounts receivable loan, your lender advances a percentage of the invoice value as either a term loan or line of credit.
Here’s a step-by-step look at how AR financing works.
- Apply for accounts receivable financing. First, you decide which invoices to submit as collateral to a lender. It’s best to only use receivables from customers that are reliable and have a history of paying their invoices on time. If you’re working with new customers or are uncertain about the reliability of existing customers, it’s best to wait until they are more established.
- Get funded. Accounts receivable financing often comes as a line of credit, so you only borrow what you need when you need it. The advance rate is how much money the lender will give you upfront. It’s usually a percentage of the invoice value — often between 70% and 80% of the invoice amount. So if an invoice is $1,000 and the advance rate is 80%, then the lender will give you $800 right away.
- Your customer pays your invoice. With accounts receivable financing, your customer pays you directly for the invoice they received, meaning you still retain ownership of it. This is different from the process of accounts receivable factoring, where instead of receiving payment from your own customer, the factoring company pays you for the invoice and then collects payments from your customer.
- You repay the accounts receivable financing company. Once your customer pays the invoice, you pay back the loan or line of credit plus a fee and/or interest. If your customer pays the lender directly, the lender will send you the rest of your payment minus the fees or interest that you owe.
Who is accounts receivable financing for?
For AR financing to be successful, your business needs a steady flow of invoices and reliable customers who pay their invoices on time. Otherwise, it can be difficult to keep up with payments.
It can be an attractive option for businesses that can’t get approved for a traditional small business loan. Because the invoices serve as collateral, lenders may be willing to work with you, even if you have a low credit score or no prior borrowing history.
Also, while the repayment period for accounts receivable financing can range anywhere from a few weeks to a few years, it’s usually a short-term financing option. This means it’s usually best for short-term working capital needs — not for long-term financing needs like buying real estate.
Pros and cons of accounts receivable financing
If your business credit history is lacking, but you have high-quality customers or are a B2B company, accounts receivable financing might be right for you. You’ll want to consider the advantages and disadvantages so you can decide if it’s the right option for your business.
| Pros | Cons |
|---|---|
Quick access to cash. There isn't a lengthy loan application and underwriting process, so you can get the financing you need fairly quickly. Minimal credit requirements. Your invoices act as collateral, which means lenders are more concerned about your customers' creditworthiness and payment history, so you usually don't need a good credit score to qualify. Low risk. Because you're borrowing against money already owed to your business (rather than future sales that aren't guaranteed), the risk of not being able to repay the loan or line of credit is low. | Need quality invoices. Businesses without a steady stream of invoices and reliable customers may have a hard time qualifying for this type of financing. Cost. Lenders may charge interest on the loan or line of credit, a funding fee based on the loan amount, and other fees, such as application, maintenance, and processing fees, that can add up quickly. Risk of customers defaulting. If your customers don't pay their invoices, you may be unable to repay your loan or line of credit, putting you at risk for late payment charges and other financial troubles. |
Accounts receivable financing vs. accounts receivable factoring
People often confuse accounts receivable financing and accounts receivable factoring — also known as invoice factoring or factoring receivables. They sound similar, but they refer to two different financing arrangements.
The difference between the two is HOW the invoices are used. With accounts receivable factoring, a factoring company pays you a percentage of the invoice amount upfront, then collects payments from your customer. With AR financing, you maintain ownership of the invoices but leverage them as collateral to obtain a loan or line of credit.
How to apply for accounts receivable financing
Here are some simple steps you can take to apply for accounts receivable financing.
1. Evaluate your invoices.
If you can choose which invoices to submit for accounts receivable financing, choose invoices from customers who usually pay their bills on time. Avoid choosing invoices from new or unreliable customers.
2. Gather required documents and submit.
While the documentation requirements vary by lender, some common ones include:
- Your accounts receivable aging report
- Basic business details, such as your business license, articles of partnership or incorporation, and your employee identification number (EIN) or tax identification number
- Copies of recent tax returns or bank statements
- Information about outstanding invoices
The lender may also check your business and personal credit score when you apply.
3. Get funding.
Getting approved for accounts receivable financing and setting up your loan or line of credit may take as long as three or four weeks. But once approved, you’ll receive your funds in a matter of days. You’ll then have to repay the borrowed amount as well as any interest or fees, usually within a few weeks or months. Typically, your customers will pay you directly, and you then pay the lender what you owe.
What are some accounts receivable financing companies?
If you’re looking for accounts receivable financing companies to help your business cover cash flow gaps and get funding quickly, there are a variety of options available. You might want to start by looking at these accounts receivable financing lenders.
Elevation Capital
Elevation Capital is an accounts receivable financing company that provides businesses up to $5 million in financing. You can apply online or over the phone, and they will work with you to find repayment terms that fit your needs.
1st Commercial Credit
1st Commercial Credit specializes in accounts receivable financing for manufacturers, service providers, distributors, transportation companies and exporters. It can lend up to 97% of the invoice value and doesn’t require you to provide financial statements or upfront fees.
TAB Bank
TAB Bank offers accounts receivable financing for anywhere from 60% to 90% of the value of your business’s invoices. You can get started by calling them or you can fill out the contact form on the website to have a representative call you.
Accounts receivable factoring options
Some companies may offer a hybrid approach to AR financing and factoring, blurring the line between the two. If you’re open to factoring, consider invoice factoring companies like altLINE, FundThrough, or Triumph Business Capital.
Frequently asked questions
Your accounts receivable is not generally considered a debt. It’s an asset because it represents money owed to you by customers.
When businesses use accounts receivable financing, they put their accounts receivables (an asset) up as collateral. The accounts receivables still aren’t debt, but the loan or line of credit they take out is a debt.
Say you have $10,000 of accounts receivables for services you’ve provided to other businesses. Those invoices aren’t due for 60 days, but you need cash now to pay for inventory.
Accounts receivable financing may allow you to borrow anywhere from $6,000 to $9,000, using your AR as collateral. Once your customers pay you, you can repay the loan.
The four forms of accounts receivable financing are:
- Factoring. Invoice factoring is a form of financing in which a company sells its invoices to a factoring company in exchange for immediate cash. The factoring company then collects payments from the company’s customers and pays back the loan over time.
- Accounts receivable loan. An accounts receivable loan is a type of funding that allows you to use your receivables as collateral for a loan or line of credit.
- Asset-based lending. Asset-based lending is a form of accounts receivable financing in which a business can use its assets, such as inventory or accounts receivables, as collateral to obtain a loan or line of credit from a lender.
- Purchase order financing. Purchase order financing is a form of financing designed to help businesses fulfill large purchase orders. When you receive a large order, the lender provides the funding necessary to pay your suppliers. In exchange, the lender places a lien on the purchase order and related receivables. Once you fulfill the order and receive payment from your customer, you repay the loan or line of credit.