Accounts Receivable Finance: A Guide

Accounts receivable finance might sound like a niche area of business funding, but there are a number of different products that allow businesses to use their accounts receivable i.e. unpaid invoices, to generate cash.

What is Accounts Receivable Finance?

Very simply, accounts receivable finance allows businesses to receive early payment on their outstanding invoices. Rather than waiting for 30, 60 or even 90 days for invoices to be paid by the customer, a company can commit all, or some, of its outstanding invoices to a funder for early payment in return for a fee.  Typically, funders can release anything from 70 to 95 percent of the value of an invoice within as little as 24 hours.

Importantly, accounts receivable is technically not lending, but an asset purchase, as you effectively sell invoices to the finance provider. That means there is no impact on outstanding loans or future requirements for lines of credit.

What Products are Available?

There are two types of accounts receivable finance:

  • Invoice Discounting – A form of asset-based finance which allows businesses to release the cash tied up in invoices. This type of finance is best suited to established businesses who sell to large customers as the finance provider’s risk depends on the creditworthiness of the customer. In this type of arrangement, the business retains control of its credit control process and continues to collect payments from the customer itself.

The different types of invoice discounting deals available include:

  • Selective invoice discounting – You can pick and choose to raise finance against single or a batch of invoices.
  • Confidential invoice discounting – The customer is unaware you are working with a finance provider and makes payments into your bank account as normal.
  • Disclosed invoice discounting – The arrangement is disclosed to customers and they make payments into an account set up by the finance provider.
  • Invoice Factoring – This type of accounts receivable finance tends to be used by smaller businesses, including start-ups, who need quick access to working capital to fund their growth. The difference between factoring and invoice discounting is that the credit control and collections function in a factoring facility becomes the responsibility of the finance provider. They credit check customers, chase payments and deal with them on your behalf.

The different types of factoring include:

  • Whole ledger factoring – The entire sales ledger is effectively sold to a finance provider.
  • Spot factoring – You pick and choose which invoices you want to raise finance against.

What Types of Business can Benefit from Accounts Receivable Finance?

This type of finance is often used by businesses that:

  • Have irregular cash-flow cycles
  • Operate in an industry where long payment terms are the norm
  • Have just one or two large customers
  • Have irregular sales or are affected by seasonality
  • Are growing quickly and need to free up cash to fund it
  • Want to bridge the cash-flow gaps created by late customer payments
  • Want to take capitalise on new opportunities

What are the Benefits of Accounts Receivable Finance?

Every business finance solution has its advantages and disadvantages and accounts receivable finance is no different. However, there is a compelling list of benefits that have seen accounts receivable finance experience a surge in popularity in the UK and around the world. That includes:

  • No assets or guarantors are required as security apart from the invoice
  • There’s no dilution in your ownership of the business
  • The amount of finance you can access grows in line with your business
  • You can access cash extremely quickly once the agreement is set up
  • The time you would spend chasing payments can be spent focusing on your business
  • The business incurs no additional debt
  • It can be used in conjunction with other types of finance
  • It converts accounts receivable into cash, which can make your balance sheet more attractive to investors

What are the Disadvantages of Accounts Receivable Finance?

There are also some potential downsides to this type of finance. That includes:

  • A loss of control of certain business processes. In a factoring agreement, you could be told to stop doing business with a particular customer if they have a poor credit history
  • Your profit margin will fall as you lose a percentage of every invoice you ‘sell’
  • The length of the contract with the finance provider might be longer than you would like
  • There used to be a stigma attached to this type of finance and some customers may assume your business is struggling

What’s the Next Step?

If your business is having difficulty securing traditional types of funding, or the regular cash injection this type of finance can provide is a good fit for your business, this could be an option for you. However, it’s important you are aware of the costs, risks and possible downsides of any finance option before you commit.

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