Accounts Receivable Financing by Alicia Tuovila

TL;DR - Definition, explanation, pros, and cons of accounts receivable financing

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Tags - accounts receivable (AR) financing, pros and cons of AR financing, AR financing structures, AR asset sales, AR loans

Questions answered:

  • What is accounts receivable (AR) financing?
  • How does AR financing work?
  • What are some companies that offer AR financing?
  • What are some systems that link business AR records to AR financing platforms?
  • What are the pros and cons of AR financing?

Summary:

  • Accounts receivable (AR) financing is a type of financing arrangement in which a company receives financing capital related to a portion of its accounts receivable.
  • AR are assets equal to the outstanding balances of invoices billed to customers but not yet paid.
  • AR are considered highly liquid assets (theoretical value for lenders and financiers).
  • The process of AR financing is often referred to as factoring; AR financiers are often called factoring companies.
  • AR financing is becoming more popular with the development of new technologies helping to link business AR records to AR financing platforms (which makes it convenient for companies to potentially sell individual invoices as they are booked and receive immediate capital from financiers)
  • AR financing may be slightly easier for a business to obtain than other financing methods - especially for small firms easily meeting AR financing criteria or large companies capable of easily integrating technology solutions.
  • Types of AR financing structures:
    • Asset Sales
      • Typical structure in which a company sells AR to a financier
      • Received capital, as a cash asset, replaces the AR on the business’s balance sheet.
      • Depending on the terms, a financier may pay up to 90% of the value of AR.
      • The financier takes responsibility for collections of AR; in some cases, the financier may also provide cash debits retroactively if invoices are fully collected.
      • Most financiers focus on short-term receivables rather than defaulted receivables in order to minimise the default risk associated with AR.
      • Financiers make money on the principal to value spread and also charge fees.
      • Example: BlueVine pays approximately 90% of AR value and will pay the rest minus fees once an invoice has been paid full
    • Loans
      • Can be structured in various ways based on the financier.
      • Advantage: AR are not sold to financiers; a company simply receives an advance based on its AR balances.
      • May be unsecured or secured with invoices as collateral.
      • AR lending companies such as Fundbox offer AR loans and lines of credit based on AR balances; a business must repay the balance over time (usually with some interest and fees).
  • Examples of systems that link business AR records to AR financing platforms include: QuickBooks, Xero, and Freshbooks.
  • AR owed by large companies may be more valuable than those owed by small companies.
  • Newer invoices (longer collection shelf-life) are usually preferred over older invoices.
  • Pros of AR financing:
    • Companies get instant access to cash without dealing with long waits associated with getting a business loan.
    • Companies using their AR for asset sales do not have to worry about AR collections.
    • Companies receiving AR loans may be able to immediately obtain 100% of the value.
  • Cons of AR financing:
    • AR financing can cost more than traditional financing, especially for companies with poor credit.
      • For asset sales, companies may lose money from the spread paid for AR.
      • With a loan structure, interests may be high or much more than discounts/default write-offs .

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