As an entrepreneur or small business owner, you’ve likely faced barriers getting working capital to fund your expansion or cover occasional cash flow shortages. You’ve no doubt realized that traditional bank loans are often an uphill battle that demand significant collateral and a high credit score.

If any of these scenarios apply to your business, you may want to consider accounts receivable (A/R) financing. In the right circumstance, this lending solution can help you get the working capital you need at the right price.

Accounts Receivable Financing: How It Works

Accounts receivable financing is a type of asset-financing that allows a business to use its invoices or money owed by customers as collateral in a loan. Under such an agreement, an A/R lender, also referred to as a factor company, disperses a loan equal to a reduced value of the unpaid invoices.

In other words, A/R financing allows your business to receive early payment on its outstanding invoices. The business will commit some or all of its outstanding invoices to the factor company for early payment.

According to Prime Revenue, there are three types of A/R financing:

  • Asset-based lending (ABL): Also referred to as a business line of credit, an ABL loan usually has the business commit the majority of its receivables. This option often comes with less flexibility than other A/R financing solutions.
  • Traditional factoring: Under a factor model, a business sells its A/R to a funder and receives an initial loan payment that is less than the full receivable. As an example, a business may receive early payment for 85% of its receivable amount, minus fees. This type of loan typically carries more flexibility than the ABL option, but may also have higher fees.
  • Customizable A/R finacing: Some funders allow for customizable A/R financing. This allows the borrower to pick and choose how much receivable to advance for early payment. These loans often allow businesses to receive an advanced payment for the full amount of the receivable.

Although there are plenty of A/R financing options available, not all are suited for your business. At Red Door Capital, we don’t believe in a “one-size-fits-all” solution. That’s why we work with you to identify the best financing options for your specific needs and goals. Refer to our Solutions page to learn more about our financing options.

Working with us ensures you get cash when the work is completed, not when your customer feels like paying you.

Pros and Cons of Accounts Receivable Financing

Like any other financing option, Account Receivable loans carry pros and cons. It’s important to consider both when exploring this route.

Pros

  • Quick Cash: The most obvious benefit of Account Receivable financing is access to quick cash. Whether you’re looking to replace equipment, re-stock inventory or make payroll, an A/R loan can put money in your pocket. Best of all, it can do so quicker than other types of loans. If raising cash is an immediate business concern, Account Receivable financing is your short-stop.
  • Save Time: Accounts receivable is a time-consuming exercise that often involves an entire accounting department. Rather than chase down all your customers, an A/R loan can fund your day-to-day business operations, enabling you to focus on what matters.
  • Free Up Working Capital: Depending on the nature of your business, accounts receivable can free up your working capital so you can fund essential business costs. This is especially helpful for retail businesses that need to re-stock inventory on a regular basis. With an A/R loan, you can essentially tap into that funding stream to grow your business.
  • No Collateral Needed: Unlike other lending programs, Account Receivable financing doesn’t require collateral. Business factoring loans are a type of unsecured debt, so you won’t have to put up your property, automobile or inventory on the line to cover the loan.

Automating your accounts receivable is one of the best ways to reduce costs. It can also help your business maximize efficiency and hasten the turnaround time from invoicing to getting paid. To learn more about the power of A/R automation, check out: Ten Ways to Automate Your Small Business for Maximum Efficiency.

Cons

  • Negative Perception: Some people equate Account Receivable financing with a struggling business, believing that only weak companies rely on loans to run their operations. Of course, this couldn’t be further from the truth. An A/R loan simply gives you an advance of the funds you are already owed so that you can cover essential business functions like payroll and inventory.  For many industries, Days Sales Outstanding (DSO) is 60 days. This means it takes a business 60 days to receive payment for a product or service it already delivered!
  • Cost: Every savvy business owner knows that nothing in life comes free. Although A/R financing can inject your business with some much needed cash, it also comes at a cost. That’s why it’s important to speak with a professional when deciding on an ideal funding option.
  • Contract Length: Not all accounts receivable financing options are the same. Although all A/R loans require a contract, some are lengthier than others. The good news is the market is changing, and increased competition is giving rise to shorter contracts that can give you more flexibility down the road.
  • Financing Is Based on Your Customers: Unlike conventional loans, where your credit is being judged, an A/R loan passes the judgment on to your customers. A large share of slow-paying clients or customers with bad credit could potentially limit your ability to access an A/R loan.

Red Door Capital helps small business owners carefully weigh both the pros and cons of accounts receivable financing. If you decide to go this route, we can link you to competitive lenders who can help you get accessing to the financing you need.

Call us today to explore your options.

Sources

Investopedia. Accounts Receivable Financing.

Kabbage.com (December 12, 2013). Accounts Receivable Financing: Pros and Cons.

Prime Revenue. What is Accounts Receivable Financing.