What Is Accounts Receivable Financing? Definition and Structuring (2024)

What Is Accounts Receivable Financing?

Accounts receivable (AR) financing is a type of financing arrangement in which a company receives financing capital related to a portion of itsaccounts receivable. Accounts receivable financing agreements can be structured in multiple ways usually with the basis as either an asset sale or a loan.

Understanding Accounts Receivable Financing

Accounts receivable financing is an agreement that involves capital principal in relation to a company’s accounts receivables. Accounts receivable are assets equal to the outstanding balances of invoices billed to customers but not yet paid. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payment required within one year.

Accounts receivable are one type of liquid asset considered when identifying and calculating a company’s quick ratio which analyzes its most liquid assets:

Quick Ratio = (Cash Equivalents + Marketable Securities + Accounts Receivable Due within One Year) / Current Liabilities

As such, both internally and externally, accounts receivable are considered highly liquid assets which translate to theoretical value for lenders and financiers. Many companies may see accounts receivable as a burden since the assets are expected to be paid but require collections and can’t be converted to cash immediately. As such, the business of accounts receivable financing is rapidly evolving because of these liquidity and business issues. Moreover, external financiers have stepped in to meet this need.

The process of accounts receivable financing is often known as factoring and the companies that focus on it may be called factoring companies. The best factoring companies will usually focus substantially on the business of accounts receivable financing but factoring in general may be a product of any financier. Financiers may be willing to structure accounts receivable financing agreements in different ways with a variety of different potential provisions.​

Key Takeaways

  • Accounts receivable financing provides financing capital in relation to a portion of a company’saccounts receivable.
  • Accounts receivable financing deals are usually structured as either asset sales or loans.
  • Many accounts receivable financing companies link directly with a company’s accounts receivable records to provide fast and easy capital for accounts receivable balances.

Structuring

Accounts receivable financing is becoming more common with the development and integrations of new technologies that help to link business accounts receivable records to accounts receivable financing platforms. In general, accounts receivable financing may be slightly easier for a business to obtain than other types of capital financing. This can be especially true for small businesses that easily meet accounts receivable financing criteria or for large businesses that can easily integrate technology solutions.

Overall, there are a few broad types of accounts receivable financing structures.

Asset Sales

Accounts receivable financing is typically structured as an asset sale. In this type of agreement, a company sells accounts receivable to a financier. This method can be similar to selling off portions of loans often done by banks.

A business receives capital as a cash asset replacing the value of the accounts receivable on the balance sheet. A business may also need to take a write-off for any unfinanced balances which would vary depending on the principal to value ratio agreed on in the deal.

Depending on the terms, a financier may pay up to 90% of the value of outstanding invoices. This type of financing may also be done by linking accounts receivable records with an accounts receivable financier. Most factoring company platforms are compatible with popular small business bookkeeping systems such as Quickbooks. Linking through technology helps to create convenience for a business, allowing them to potentially sell individual invoices as they are booked, receiving immediate capital from a factoring platform.

With asset sales, the financier takes over the accounts receivable invoices and takes responsibility for collections. In some cases, the financier may also provide cash debits retroactively if invoices are fully collected.

Most factoring companies will not be looking to buy defaulted receivables, rather focusing on short-term receivables. Overall, buying the assets from a company transfers the default riskassociated with the accounts receivables to the financing company, which factoring companies seek to minimize.

In asset sale structuring, factoring companies make money on the principal to value spread. Factoring companies also charge fees which make factoring more profitable to the financier.

BlueVine is one of the leading factoring companies in the accounts receivable financing business. They offer several financing options related to accounts receivable including asset sales. The company can connect to multiple accounting software programs including QuickBooks, Xero, and Freshbooks. For asset sales, they pay approximately 90% of a receivables value and will pay the rest minus fees once an invoice has been paid in full.

Loans

Accounts receivable financing can also be structured as a loan agreement. Loans can be structured in various ways based on the financier. One of the biggest advantages of a loan is that accounts receivable are not sold. A company just gets an advance based on accounts receivable balances. Loans may be unsecured or secured with invoices as collateral. With an accounts receivable loan, a business must repay.

Companies like Fundbox, offer accounts receivable loans and lines of credit based on accounts receivable balances. If approved, Fundbox can advance 100% of an accounts receivable balance. A business must then repay the balance over time, usually with some interest and fees.

Accounts receivable lending companies also benefit from the advantage of system linking. Linking to a companies accounts receivable records through systems such as QuickBooks, Xero, and Freshbooks, can allow for immediate advances against individual invoices or management of line of credit limits overall.

Underwriting

Factoring companies take several elements into consideration when determining whether to onboard a company onto its factoring platform. Furthermore, the terms of each deal and how much is offered in relation to accounts receivable balances will vary.

Accounts receivables owed by large companies or corporations may be more valuable than invoices owed by small companies or individuals. Similarly, newer invoices are usually preferred over older invoices. Typically, the age of receivables will heavily influence the terms of a financing agreement with shorter term receivables leading to better terms and longer term or delinquent receivables potentially leading to lower financing amounts and lower principal to value ratios.

Advantages and Disadvantages

Accounts receivable financingallows companies to get instant access to cash without jumping through hoops or dealing with long waits associated with getting a businessloan. When a company uses its accounts receivables for asset sales it does not have to worry about repayment schedules. When a company sells its accounts receivables it also does not have to worry about accounts receivable collections. When a company receives a factoring loan, it may be able to obtain 100% of the value immediately.

Although accounts receivable financing offers a number of diverse advantages, it also can carry a negative connotation. In particular, accounts receivable financing can cost more than financing through traditional lenders, especially for companies perceived to have poor credit. Businesses may lose money from the spread paid for accounts receivables in an asset sale. With a loan structure, the interest expense may be high or may be much more than discounts or default write-offs would amount to.

What Is Accounts Receivable Financing? Definition and Structuring (2024)

FAQs

What Is Accounts Receivable Financing? Definition and Structuring? ›

Accounts receivable (AR) financing is a type of financing arrangement in which a company receives financing capital related to a portion of its accounts receivable. Accounts receivable financing agreements can be structured in multiple ways usually with the basis as either an asset sale or a loan.

What are the four forms of receivable financing? ›

4 Types of Accounts Receivable Financing
  • Factoring. Invoice factoring is when a company sells its invoices to a factoring company, which then collects payments from its customers. ...
  • Invoice discounting. ...
  • Accounts receivable loans. ...
  • Purchase order financing.
May 15, 2024

What is the difference between accounts receivable financing and factoring? ›

A/R financing provides you a pool of funds to borrow against your invoices, while factoring is the process of selling an invoice, receiving a cash advance, and ultimately paying a small fee on each individual invoice once your customer pays and the remaining value of the invoice is funded to your business.

What is the difference between accounts receivable financing and inventory financing? ›

Working Capital

Both types of funding give easy access to better cash flow for businesses. Inventory financing focuses on providing cash to ensure companies have enough capital to stock extra or enough inventory for the business, whereas accounts receivable financing gives capital to ease a business' cash constraints.

What are the three types of accounts receivable? ›

Receivables can be classified into accounts/trade receivable, notes receivable, and other receivables.

What is the 10 rule for accounts receivable? ›

The rule states that when a customer has more than 10% of their total balance aged over 90 days, the remaining balance is also deducted as ineligible.

What is another name for accounts receivable financing? ›

Accounts receivable financing, also known as invoice financing or invoice discounting, allows businesses to borrow capital against the value of their accounts receivable — in other words, their unpaid invoices.

What is an example of receivable finance? ›

To take factoring as an example, the receivables finance process may go like this: Seller sells goods to buyer. Seller issues an invoice to the buyer. Seller sells the invoice to the factor.

What is AR financing terms? ›

Accounts receivable financing often comes as a line of credit, so you only borrow what you need when you need it. The advance rate is how much money the lender will give you upfront. It's usually a percentage of the invoice value — often between 70% and 80% of the invoice amount.

How does accounts receivable financing work? ›

Accounts receivable or AR financing is a type of financing arrangement which is based on a company receiving financing capital in return for a chosen portion of its accounts receivable. An AR financing arrangement can be structured in several ways, including as an asset sale or a loan.

What accounts receivable financing might include? ›

In this type of agreement, a company sells accounts receivable to a financier. This method can be similar to selling off portions of loans often done by banks. A business receives capital as a cash asset replacing the value of the accounts receivable on the balance sheet.

What is the difference between invoice financing and AR financing? ›

Accounts receivable financing, also known as invoice financing, is slightly different to factoring. The main difference is that you retain ownership of the invoices and the responsibility of collecting payments on them. Here's how it works: You have outstanding invoices that are due to be paid by customers.

How does AR factoring work? ›

Accounts receivables factoring is a financial practice where a company sells its invoices to a third-party financial institution at a discount for immediate cash. The factor collects payment from customers, and the company receives funding without waiting for payment or taking on additional debt.

Is receivables financing off balance sheet? ›

Off Balance Sheet Financing

A standard receivables finance program aims to improve the working capital and the treasury of the client. Off Balance Sheet Financing offers more possibilities. In fact, such financing responds to a need to lighten the balance sheet and improve debt ratios (leverage and financial autonomy).

What is the difference between payable financing and receivables finance? ›

In summary, payables finance involves financing by paying outstanding invoices early, at a discount, leveraging outstanding invoices to suppliers, while receivables finance involves financing by selling outstanding invoices to a financing institution.

How do you organize receivables? ›

Have a look at our free guide with tips to improve your A/R management!
  1. 8 tips to improve your accounts receivable management. ...
  2. Use Electronic Billing & Online Payments. ...
  3. Use the Right KPIs. ...
  4. Outline Clear Billing Procedures. ...
  5. Set Credit & Collection Policies — and Stick to Them. ...
  6. Collect Payments Proactively. ...
  7. Set up Automations.
Jun 20, 2024

How to organize accounts receivable files? ›

Accounts Receivable:
  1. Keep Sales Invoices in numerical order, keeping unpaid invoices at the top of the folder. This allows for quick and regular review of what is outstanding.
  2. After Deposits have been entered, attach the cheque stub to the back of the invoice and file in numerical or alphabetical order.

What is the structure of the AR department? ›

The Accounts Receivable Department typically consists of several key roles. These include AR clerks who handle invoicing and payment processing, credit analysts who assess customer creditworthiness, and collection specialists who manage overdue accounts.

References

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