What Is Accounts Receivables Financing?
Accounts receivables financing is a quickly flourishing phenomenon to sustain capital by financing outstanding invoices.
The procedure has recently picked momentum in countries such as Hungary, Armenia, Turkey, and others.
Businesses commit their outstanding invoices to an external lender for instant payment in return for a fee. Receivables financing companies generally pay a sizable percentage of the invoice.
The remaining balance, minus the fees, is deposited upon the payment of the invoice by the original customer.
What Are Accounts Receivables?
Accounts receivables (AR) refer to the outstanding balance that a company is due on account of the services or goods that it has delivered to its clients.
A company’s accounts receivables will be marked as the current assets on the balance sheet.
One can think of AR as the money owned by a purchaser to the seller/supplier of goods and services.
- Account receivables mustn’t be confused with account payables as the latter refers to the money owed while the former refers to the money to be received
- Since account receivables are treated as an asset, they can be financed by advancing or factoring by receivables financing companies
- The value of AR is gauged by the strength of the turnover ratio. This refers to the likelihood of the invoice being paid in a short time
The Types Of Receivables Financing
When it comes to financing invoices, there are three go-to methods designed to help.
The primary receivable finance methods include asset-based lending (ABL), traditional factoring, and selective receivables finance.
The difference between these rests on whether the invoicing collectibles are sold or lent to the lender.
Traditional Invoice Factoring
With this method of financing invoices, receivables are sold to an external lender for an amount less than the AR’s outstanding balance.
The lender pays a sizable percentage of the balance to the owner of the original invoice along with charging an initial fee.
The remaining balance is delivered after the customer related to the financed invoice pays the sum.
The lender will continue to charge a weekly fee for as long as the payment is delayed. This weekly fee is called a factor.
Finally, upon the financing of the invoice, the lender will return the balance minus the factors and the original fee.
Traditional factoring allows a business the freedom to choose which AR it would like to trade for immediate payment. However, the processing fee and factors included make it, at times, a costly deal with narrow credit lines.
Asset-Based Lending (ABL)
This method of financing invoices falls within the category of traditional commercial lending.
ABL or a business line of credit relies on an on-balance sheet technique.
The majority of a business’ collectibles are committed to a lender without granting the AR owners much say in which assets are committed.
Unfortunately, ABL also involves significant processing fees that can put some strain on your credit.
Selective Receivables Finance
With this financing technique, businesses are granted the freedom to advance accounts payables of their choice.
Based on the structure of the program, the assets you commit may be released from accounting as debt.
By remaining off the balance sheet, they don’t pose any threat to your credit score or debt ratios.
Selective receivables financing also comes with lower processing fees and greater flexibility.
Advanced payments are generally made for an AR’s complete worth of outstanding balance but instead of being sold, they are simply committed to an invoice financing company.
The business advancing the ARs to a lender keeps the responsibility of ensuring that the payment is made by the client.
Receivables Financing Tool Is Best and How Can Invoicing Software Help?
Selective Receivables Financing is generally preferred by businesses for the following reasons.
- Committed Asset is Not Considered Debt: Based on the program structure, the committed receivables aren’t treated as debt. In this way, they refrain from impacting your credit score for future borrowing
- Flexibility to Pick and Choose: Businesses not only have flexibility in committing ARs to external funders of choice, but also when to engage in advancing finance. For businesses experiencing some kind of economic volatility, this is a key advantage
- Freedom to Incorporate Multiple Funders: You can commit your accounts payables to multiple lenders at the same time. This allows you to tap into multiple revenue sources in a single instance. Since advancers don’t rely on one institution, they aren’t bound to any economic risk or malfunction that a financer, such as a bank, may suffer
- Favorable Processing Rates: Having multiple funding options also means you can leverage the competition in your favor
Invoicing software for small businesses can also help with managing cash flows by automating calculations and bringing visibility to them in real-time.
This, along with the invoice financing techniques, can greatly reduce the external strain that comes with manually creating, advancing, and tracking accounts payables and receivables.