A Small Business Owner’s Guide to Accounts Receivables Financing

Are you a small business owner facing cash flow problems? It’s a pretty common situation, but there is hope – accounts receivables financing can be an ideal solution to your needs, providing you with liquidity, ensuring that you’re able to grow your business, and avoiding the stagnation that comes from waiting for slow-to-pay clients and customers.

Of course, if you’re going to benefit from this financial tool, you’ll need to know more about what it is, how it works, how it differs from conventional lending and other funding options, and more. In this guide, we’ll cover all those topics and more.

What Is Accounts Receivables Financing?

Perhaps the best place to start the discussion of accounts receivable financing is with what it actually is. In essence, it’s a means to unlock capital in your business that’s tied up in unpaid invoices.

Accounts Receivables FinancingYour accounts receivable represent money owed to your business by your clients or customers. And, while those accounts might put you in the black, the fact that they’re not yet paid means that you could be suffering from a lack of liquidity. Cash flow is needed for many things, including:

  • Paying utilities
  • Investing in growth opportunities
  • Purchasing supplies or materials for new projects
  • Marketing and advertising
  • Paying employees

You get the picture. If most of your company’s capital is tied up in unpaid invoices, it creates a serious financial strain. Accounts receivable financing is simply a means of unblocking the flow of capital through your business.

How does it actually work, though? This brings us to our next topic of discussion.

How Accounts Receivables Financing Operates

Understanding the principles behind accounts receivables financing is easy. It’s actually a very simple process and looks something like this:

  • You bill a client or customer for products purchased or services performed.
  • You sell that invoice to a factoring company.
  • The factoring company advances you between 70% and 90% of the invoice total.
  • You spend that cash on business needs.
  • Your client pays the invoice total to the factoring company.
  • The factoring company pays you the remainder of the invoice total, less the “factoring fee” agreed upon at the beginning.

That’s it – that’s all there is to it. There’s no credit check, no need for collateral, and no waiting involved. You sell the invoice and get the cash you need to ensure that your business is able to keep growing.

So, how does accounts receivable financing compare to bank loans or business lines of credit? Let’s take a closer look.

Comparing Accounts Receivables Financing to Other Options

As a business owner, you have quite a few options available to you when it comes to obtaining cash to grow your business. You can wait for your customers to pay their invoices, for one. You could look for a loan from a bank, for another. You might consider obtaining a business line of credit, as well. However, none of those methods offers the benefits you’ll find with accounts receivables financing. Why is that?

It’s all tied into the nature of the different transactions. Let’s break them down into further detail below so you can see just how accounts receivables financing compares.

Waiting for Clients to Pay

Perhaps the simplest solution to your cash flow needs is just to wait until your customers or clients pay their bills. This involves no extra effort – just some patience on your part. However, what happens during the interim? Most B2B invoices are offered on terms today. Your customer might have 30, 60 or even 90 days to pay their bill.

What do you do in the meantime? What if waiting for your customers to pay their bill means that you’re not able to take on new clients? That’s a very real possibility, particularly for small businesses focused on services. Let’s say that your company focuses on renovating and improving historic buildings for modern needs. You’re in the process of revitalising the downtown area of your town.

You’ve just completed one project, and are waiting on the client to pay, when you’re approached to renovate the building across the street, transforming what was once a hardware store into a hip eatery. You’d love to, but you don’t have the cash for the supplies and materials, or the labor for that matter. In this instance, waiting for a client to pay is actually costing you business.

Bank Loans

You might think that getting a loan from a bank would be the solution to your cash flow needs, but that’s not the truth. Why not?

Think about the way that lenders have tightened their criteria in recent years. Even business owners with spotless credit are having a difficult time obtaining conventional loans. And chances are good that your credit isn’t as good as it could be. Combine that with slow cash flow, and a lender might not be willing to give you the time of day, much less a loan.

Another reason that a bank loan might not be the ideal solution here is that it’s capped – you can only borrow so much money. When it’s gone, it’s gone. With accounts receivables financing, you just sell another invoice to get more cash flow.

Finally, there’s the fact that a bank loan is just more debt. Accounts receivables financing is not. There’s no additional liability for your company here, and nothing to drag down your financial standing. That also means there are no ongoing payments to meet. Making monthly loan payments to the bank will ultimately just increase your financial difficulties, not alleviate them.

Business Line of Credit

Business lines of credit can be valuable tools that enable you to achieve growth and success. However, they’re not as beneficial as they seem. In the end, that line of credit is just more debt that you’ll have to repay – another mark against you.

Like bank loans, lines of credit come with monthly payments, and caps, too. Ultimately, you’ll find that these financial tools really just help you dig that hole deeper, going into more debt and incurring more difficulty.

Also, just like bank loans, it can take up to two months to even secure a line of credit. That means you’re better off waiting for your customers to pay their bills than you are trying to use a loan or line of credit to offset immediate cash flow needs.

Now, let’s compare those financial tools to accounts receivables financing and see how things stand.

Accounts Receivables Financing

Now, compare accounts receivables financing to those tools. Unlike bank loans and lines of credit, this situation does not involve taking on more debt. In fact, it really offers the means to unlock capital that you already own. That means you won’t be taking on yet another monthly payment. It also means that the focus of the factoring company offering the financing is not on your business’ creditworthiness.

Most companies can qualify for this whether they have good credit, bad credit, or something in between. Factoring companies focus not on you, but on your clients. If they have good credit and a history of on-time payments, then you’re in the clear.

Another benefit here is the speed with which you’re able to obtain your funding. With bank loans and lines of credit, you can wait up to two months. If you decide to wait for your customer to pay, that might be a month, two months, or even three months. With accounts receivables financing, you can generally have your money within 24 to 48 hours. Obviously, that’s a significant difference.

Now, while this process can be highly beneficial, there are a few things that you’ll need to know before selling an invoice to a factoring company, and we’ll cover those below.

What to Know Before Choosing a Factoring Company

While working with a factoring company can provide you with the infusion of cash you need to run a successful business, there are several things you’ll need to know prior to signing a contract with one.

How Much Is the Advance?

Factoring companies will generally advance you between 70% and 90% of the invoice total. You’ll need to know exactly how much they’re offering beforehand so you can make an informed decision.

How Much Is the Fee?

In order to turn a profit, factoring companies charge a fee. It’s taken from the balance of the invoice after your client pays. In general, this is usually between 1% and 5% of the invoice total. Obviously, if the invoice is large, and the company charges 5%, you could be parting with a significant amount of money.

Can You Afford to Lose Some Cash?

Let’s be clear on one thing – working with a company for accounts receivable financing will never give you 100% of what your client owes you. The factoring company will always take some as a factoring fee so they can be profitable. However, some businesses run with very small profit margins, and the factoring fee (and other charges and fees) could eat that margin away.

Know how much you can afford to lose before you decide that factoring is the right path for your particular business to take. If you need 100% of the invoice total to ensure your profit, then invoice factoring might not be the right option and you may be better off waiting for your customer to pay in the first place.

Are There Any Hidden Fees?

Ideally, you’ll only pay a factoring fee with accounts receivables financing. However, some factoring companies do assess other charges. Look for terms like the following in your contract before signing on the dotted line:

  • Maintenance fee
  • Management fee
  • Account access fee

There may be other charges hidden away in the fine print of your contract as well, so give it a close eye. If you’re not 100% sure about a particular term, ask the company representative to clarify. It may also be beneficial to have your attorney look over the contract before you sign to ensure that you’re not working with a predatory company.

How Much Control Do You Give Up?

There’s a loss of control to some degree with all factoring companies. This is because once you sell the invoice to the company, they take over collections. However, some factoring companies require that you sacrifice even more control. They will want you to sell all invoices for that client moving forward, and they will act as your billing and collections department.

This may be a good thing for your business, but it might not. If you have significant needs when it comes to discretion, you might want to think twice about working with a company that requires you to sell all of your invoices for a particular client. Spot financing, or the ability to pick and choose which invoices you sell, might be a better option.

From the information above, you can clearly see that while accounts receivables financing can be beneficial, allowing you to build a successful business, it’s not a simple once-and-done type of thing. You’ll need help. That’s where we come in.

We’re Here to Help

Finding the right factoring company can be immensely challenging. This is particularly true if you’ve never worked with accounts receivables financing before. We’ve spent years working with our clients to understand their needs and then match them with the right factoring company, and we can do the same for you. We invite you to take advantage of a free consultation with one of our factoring specialists to get the process started and begin building a strong, stable company.