What is receivables financing?
Accounts receivable financing is a financing option available to business owners who want to use their accounts receivables as collateral for a loan. This type of financing can be used to free up working capital, which can be used for expansion or other business needs.
Receivables financing agreements can be either short-term or long-term, depending on the needs of the business. This type of financing agreement is structured in several different ways, with the basis being a loan or an asset sale.
How does receivables financing work in practice?
Accounts receivable financing is, in its most basic form, an agreement that involves the capital principal borrowing against the accounts receivables of the business. The accounts receivable are used as collateral for the loan. In most cases, businesses that opt for accounts receivable financing do so because they need working capital, and do not want to take on more debt.
Accounts receivables are reported as current assets on the balance sheet. This type of financing is a way for business owners to tap into those assets without having to sell them outright.
Under an accounts receivable financing agreement, the lender will advance a portion of the total value of the receivables minus a fee. The fee is generally a percentage of the total value of the receivables and is paid upfront. The borrower will then make periodic payments to the lender, with the final payment due when the receivables are collected.
Why is receivables financing used by startups?
The main reason that accounts receivable financing is used is that it allows business owners to access the working capital they need without taking on more debt. This type of financing agreement can be beneficial for businesses that have a lot of accounts receivables but may not be able to qualify for a traditional bank loan.
Receivables financing also reduces the delay between when a product or service is sold and when the payment is received. This can help businesses to better manage their cash flow.
When should you use receivables financing?
The ideal time to use accounts receivable financing is when your business is growing, and you need working capital to finance that growth. This type of financing can also be used to free up cash flow so that you can invest in other areas of your business.
It is important to note that accounts receivable financing should not be used as a long-term solution. This type of financing is typically used for short-term needs.
Can you provide an example of receivables financing in action?
Suppose a business sells culinary products to restaurants and other food service businesses. The business receives a bulk purchase order from a new customer (the debtor) for $500,000 worth of goods. The terms of the sale are that the debtor will pay in 90 days.
The business owner knows that she needs the money to buy more inventory to fulfill the order, but she does not have the $500,000 upfront. She decides to finance the receivable by entering into accounts receivable financing agreement with a lender.
Under the agreement, the lender will advance 80% of the receivable ($400,000) minus a fee. The fee is typically a percentage of the total value of the receivables and is paid upfront. In this case, let’s say the fee is 3%, this means that the business owner will receive $388,000 from the lender.
The business owner will then make periodic payments to the lender, with the final payment due when the receivable is collected. In this case, the terms of the financing agreement may be that the business owner will pay back the remaining $112,000 over six months.
What are the advantages of raising capital via receivables financing?
There are a few key advantages of accounts receivable financing:
- It can be easier to qualify for than a traditional bank loan
- You can access the working capital you need without taking on more debt
- It can help to improve your business’s cash flow
- It can be used to finance growth or other short-term needs
What are the disadvantages of raising capital via receivables financing?
While accounts receivable financing can be a helpful tool for businesses, there are also some potential disadvantages to consider:
- You may have to pay a higher interest rate than you would with a traditional bank loan
- If you don’t manage your accounts receivables properly, it could put your business at risk
- You may have to give up a percentage of your accounts receivables
What are the typical terms of receivables financing?
The terms of accounts receivable financing will vary depending on the lender and the specific agreement. However, there are a few key terms that are typically involved in this type of financing:
- Advance rate: This is the percentage of the receivable that the lender will advance. It is typically between 70% and 90%.
- Fee: The fee is the amount charged by the lender for providing the financing. It is typically a percentage of the receivable and can range from 1% to 5%.
- Payment terms: The payment terms will outline how and when you will make payments to the lender.
Can you negotiate the terms of receivables financing?
Yes, the terms of accounts receivable financing are typically negotiable. It is important to compare offers from different lenders to see who is willing to give you the most favorable terms.
When you are comparing offers, be sure to look at the advance rate, fee, and payment terms. These are the key factors that will affect the cost of the financing and the amount of cash flow you will have available.
What are the financing alternatives to receivables financing?
Accounts receivable financing is not the only option for businesses that need working capital. There are a few other financing options to consider, including:
- Receivables factoring: This is a type of financing that allows businesses to sell their accounts receivables at a discount in exchange for cash.
- Non Dilutive Financing: This is a type of financing that allows businesses to access capital without giving up equity.
- Mezzanine Financing: This is a type of financing is a hybrid form of debt and equity financing, similar to a SAFE or convertible note.
- Bridge loan: This is a short-term loan that is typically taken out for a period of 6 to 12 month for the purpose of “holding over” a company until they can secure longer-term financing
- SAFE Note: This is a type of financing used by early-stage startups (typically seed stage) to raise capital from investors.
What are the differences between receivables financing and receivables factoring?
Accounts receivable financing and accounts receivable factoring are both ways for businesses to access the cash they need to improve their cash flow. However, there are a few key differences between these two types of financing:
- With accounts receivable financing, you are borrowing money based on your accounts receivables. With accounts receivable factoring, you are selling your accounts receivables at a discount in exchange for cash.
- Accounts receivable financing requires you to make payments to the lender, while accounts receivable factoring does not require any payments.
- With accounts receivable financing, you retain control of your accounts receivables. With accounts receivable factoring, the Accounts Receivable department is responsible for collecting payment from the customer.