Using Accounts Receivable Financing for Your Small Business
Accounts receivable financing is one of many non-traditional financing methods that can be used to quickly generate cash for your small business. Understanding how it works can help you put the pros and cons into perspective.
A Simple Explanation
Instead of waiting for individual customers to pay outstanding invoices, in receivables financing a business sells them to a third party. The amount the business receives is a percentage of the total of the invoices. While the business receives less than the amount it originally invoiced, it’s also relieved of any cost involved in attempting to collect on those invoices. Your customer will now pay the third party instead of you.
Note that not all of your company’s invoices will be eligible for accounts receivable financing. The third party considers the age of an invoice in deciding if it’s worth attempting to collect it, so any past due accounts are generally not included. The third party may also consider the customer you’ve invoiced in making their decision. Not surprisingly, invoices to large companies can be more attractive to the purchaser and may mean a larger percentage of the invoice total returned to you.
The most attractive characteristic of selling a group of invoices to a third party may be that it can result in an immediate influx of cash. Because the business is no longer waiting for payments to trickle in, it may be able to take advantage of sudden opportunities.
Another appealing feature is that no collateral is required. This means that neither company nor personal assets are put at risk in order to fund business operations. The method also does not require you to divide ownership of the company in order to make payroll or purchase inventory.
In addition to receiving a percentage of the total amount of the invoices sold, the business typically pays interest on the funds it receives as well. Consider not only what you’d pay on a month-to-month basis; also look at what the financing can cost over the term of the contract.
While accounts receivable financing is a viable financial tool, some can view it as an indication that your company is struggling. This is a consideration because when you contract with the third party, your customers are notified that they will not pay you – they must pay the company that now holds their invoice.
Small businesses may have difficulty in getting credit from traditional sources for a variety of reasons. Accounts receivable financing is one of a number of non-traditional methods of generating cash you can consider to maintain level cash flow and support growth.