In a perfect world, invoices are paid in a timely fashion, and there is ample cash on hand to fund the growth of business. Sadly, this is not always a reality for many businesses. Outstanding invoices that go unpaid for a period can cause a drain on cash reserves and often challenge owners to meet payroll and other daily expenses.
As a small business owner, you’ve likely faced the familiar problem where sales fluctuate significantly, or you have accounts receivables that remain outstanding. This cycle of boom and bust can be solved with certain asset-based loans called accounts receivable financing. In extreme cases, these loans can even help a business stay solvent and avoid defaults. Accounts Receivable loans are typically high-cost, so it’s best that they serve only as a short-term solution. For a business in a tight spot but with assets on the books, however, they can be a powerful lifeline.
Here’s a breakdown of how to use account receivable financing.
What is Accounts Receivable Financing?
Accounts receivable financing, sometimes referred to as invoice financing, is when a company uses its accounts receivable or customers credit accounts, to obtain cash loans for capital expenditures or daily operational expenses. Similar to inventory financing, accounts receivable financing involves pledging outstanding invoices as collateral for short-term loans.
Who Does the Financing?
Commercial banks occasionally offer asset financing, but you’ll typically need a commercial finance company that is experienced in structuring and administering these loans. Interest rates usually run higher than traditional bank loans.
There are typically two methods to finance accounts receivable.
Pledging Accounts Receivable
Pledging outstanding accounts receivable assets as direct collateral is one way of securing asset based loans. The lender holds the security of the invoices but the business is still responsible for collecting the outstanding debts in order to pay for the loans.
A financier will likely evaluate the age of the outstanding debt and may avoid any invoices that are overdue as they are not considered good collateral. Based on the evaluation of the company’s books and the terms of the customer credit, a percentage of 75-85% of the debt will be lent.
If the business defaults on the loans, the lender takes over the outstanding accounts and collects the debts.
Factoring Accounts Receivable
Another method of financing accounts receivable involves the actual sale, as opposed to collateralization, the outstanding invoices or credit accounts to the lender. The financing company then gives the business a payment for those invoices at 70-90% of the value. The lender typically charges and additional small percentage fee.
Although the cost for factoring accounts receivable can be high, the lender takes on the burden and the risk of collecting the debts. Avoiding debt collection can present a savings for a small company that has to chase down a significant amount of outstanding invoices.
You’ve heard the phrase “cash is king” and nowhere is this more evident than when running your business. If you’d like to know more about how we can help you get money for your business, call us for a FREE Business Funding Consultation at (800)416-7713.
Rick Anderson @FundingExpert1
Rick Anderson is the CEO and Senior Small Business Funding Specialist with Small Business Money Solutions. A company that helps small business owners and self employed professionals get the financial solutions they need to GROW and thrive. Rick has been in business for over 22 years, and his company has helped 22,485+ small business owners and counting. Rick has also written a book on small business finance entitled 10 Easiest New Money Sources For Business Owners.
Connect with him https://www.linkedin.com/in/RickAndersonSmallBusinessLoans or if you would like to ask him a question, send it to Rick@SmallBusinessMoneySolutions.com. If you’d like a FREE ‘Business Funding’ Consultation, call him at (800)416-7713.