Accounts Receivable Financing: Benefits & When to Use It

Accounts receivable financing is a form of financing that allows a business to receive income and capital based on the accounts receivable assets of the company. Accounts receivable financing is characteristic of asset-based financing offered by banks. It also describes invoice factoring, a process by which the accounts receivable assets may be sold to another party at a discount.

Asset-Based Financing

Accounts receivable, as well as inventory and human resources, are assets of a business. Accounts receivable describes goods and services that have been provided to customers on a credit basis. It realizes its value once it is converted to cash with a customer's payment. Banks engage in asset-based financing or lending to provide businesses the capital needed to operate. Financing provisions lend on the value of inventory as well as accounts receivable, with each being considered a security against debt. Most banks tie the value of an accounts receivable asset to the customer account. This relates to specifics such as whether the customer is a domestic or foreign-based, how old the outstanding invoices on the account are and what percentage of the account total is past due. Businesses pay interest on the funds they borrow from asset-based lending.

Invoice Factoring

Invoice factoring is similar to asset-based financing in that funds are being supplied for unpaid assets. Invoice factoring differs, however, in the types of financing arrangements. Some companies or factoring agents buy the accounts receivable assets altogether. They are typically purchased at a discount because the money is being given up front before being collected. If a customer should take longer to pay or default, the company purchasing the accounts receivable ends up losing profits on the deal. Other factoring arrangements pay a percentage of the value of the accounts receivable up front. The value, as with bank asset-based lending, is based on the customer account. When payment is made by the customer, the factoring agent or company takes out a fee and pays the remaining balance to you.

Financing Benefits

Financing is useful for businesses who do not have adequate working capital to sustain operations. Some small businesses have difficulty getting approved for loans. Asset-based financing and factoring can provide them with needed cash. Financing accounts receivable is also useful for companies that are not efficient at customer collections or do not wish to deal with that aspect of the business. This can allow an organization to focus more on sales-related functions and lower its payroll costs by not having employees manage the accounts receivable aspect. Financing of accounts receivable can also insure a company's credit rating and score stay positive by keeping its payment history to vendors and creditors prompt. It can also reduce the prompt-pay or early payment discounts a business offers its customers. Since the business is already receiving needed funding from another source, it has little reason to encourage customers to pay early at the expense of lower profits.