Accounts receivable funding, also known as invoice financing or factoring. This is a financial arrangement where a company uses its outstanding accounts receivable as collateral to obtain immediate cash from a financial institution. This short-term borrowing helps businesses meet short-term financial obligations and enhance cash flow.
Businesses can quickly obtain cash from their outstanding invoices through a method known as invoice factoring or accounts receivable loans. Here is a description of the typical procedure:
A company provides goods or services to its customers and generates invoices with payment terms, usually 30 to 90 days.
The company applies for accounts receivable financing with a financial institution or a factoring company. The financing provider evaluates the creditworthiness of the company's customers rather than the company itself, as the invoices act as collateral.
During the verification process, the financing provider verifies the invoices and the creditworthiness of the customers. They may conduct credit checks and assess the quality of the accounts receivable.
Based on the evaluation, the financing provider offers a financing arrangement, usually a percentage of the invoice value. The advance rate can vary, but it typically ranges from 85% to 90% of the invoice amount.
After the approval of financing offer, the financing provider transfers the agreed-upon percentage of the invoice value to the company's bank account. This provides immediate cash flow to the company.
The financing provider takes over the responsibility of collecting the payments from the customers based on the invoice terms. They may handle the entire collections process or just the payment processing, depending on the agreement.
When a customer pays an invoice, they normally send the funds straight to the finance source. The financing provider deducts their fees, which usually include a discount fee or interest, and returns the remaining amount (reserve) to the company. The reserve amount is usually between 10% to 15% of the invoice value.
Cash Flow is essential for sustainability of large capital businesses. By receiving immediate cash against outstanding invoices, companies can bridge the gap between invoicing and actual receipt of payment. This helps meet operational expenses, invest in growth opportunities, or cover unforeseen costs.
It provides businesses with better control over their working capital by converting accounts receivable into cash, allowing them to manage their finances more efficiently.
Accounts receivable financing is not considered a loan similar to a line of credits where monthly repayment with interest is involved. Instead, it uses the invoices as collateral, reducing the need for traditional borrowing. The company's creditworthiness is also less critical compared to other financing options.
By outsourcing the collections process to the financing provider, businesses can save time and resources that would otherwise be spent on chasing payments. This allows businesses to focus on expansion and core operations, which ultimately contributes to their overall success.
