What is Accounts Receivable Financing?
Poor cash flow kills up to 82 percent of start-ups and small businesses. Even strong businesses in high-demand markets can fail if they can’t maintain the cash flow they need to pay their bills on time.
But when clients are slow to pay there is often little a business can do about it. Accounts receivable financing can bridge the gap. Keep reading to learn how this innovative financing technique can help businesses ensure the cash flow they need to grow and thrive.
Accounts Receivable Financing Basics
Accounts receivable are monies owed to a business for services rendered that have not yet been paid. Financially, accounts receivable qualify as assets even though a business does not yet have that money in hand and cannot use it to pay for expenses.
This inability to access and spend money they have earned can create serious cash flow problems for businesses of all sizes. Cash flow challenges are especially burdensome to small businesses because they:
- Are less likely to have cash reserves to use for expenses
- Are less likely to be able to delay paying their own bills
- Tend to have a low ability to force clients to pay their bills quickly
Accounts receivable financing, also called factoring, is a type of financing in which businesses sell their accounts receivable to a factoring company at a discounted rate. The factoring company pays for those assets in cash, then collects and keeps the money when the business’s client pays.
Accounts Receivable Financing Example
Here is a simple accounts receivable financing example to illustrate the concept.
- Business A provides its client Mary with $500 in products or services
- Business A bills Mary for the $500, creating an accounts receivable asset, but Mary does not pay right away
- Business A then sells that asset to Factoring Company B at a discounted rate for $450
- Factoring Company B pays for the asset in cash, providing Business A with the immediate income it needs to pay its bills
- When Mary pays the $500 she owes, all of that money goes to Factoring Company B who now owns that asset
In this scenario, everyone wins. Business A gets the money it needs when it needs it, allowing it to thrive, expand, and avoid racking up late fees and penalties on its accounts payable. The factoring company earns a small commission or interest on the money it provides to Business A by paying out $450 but collecting $500.
Pros and Cons
Accounts receivable financing jobs are not without their disadvantages. Businesses do give up small amounts of their potential income in return for getting money fast.
The benefits of improved cash flow, however, far outweigh this small inconvenience.
This is especially true in situations like hospital accounts receivable financing. Factoring can provide hospitals with income they might otherwise wait years for while patients deal with insurers and lawsuits.
Click here to learn more about how accounts receivable financing can benefit businesses of every kind.
Accounts receivable financing can provide a creative and empowering solution to a common business challenge. Explore more great solutions to financial challenges by browsing the other great articles on our blog today.