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Accounts Receivable Financing Becomes a Popular Form of Business Finance

Published 9/26/2012

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As a business owner, you know how important it is to generate the capital you need to keep your doors open. Some of the many business expenses you will need to cover on a regular basis include: rent, utilities, marketing costs, salary expenses, insurance premiums, telecommunications bills, office supplies, car payments, and more. If you are a start-up, or you are not making enough revenue to cover your expenses, you must find a way to cover all of your bills. With so many different commercial financing vehicles to choose from, you might wonder which method is best for your company. Find out what accounts receivable financing is, why it is becoming a great alternative to traditional finance, and who can use this method of business finance to generate capital short-term by reading on.

What is Accounts Receivable Financing?

Accounts receivable financing is an alternative form of business finance where a third-party lender will advance businesses money and use their existing accounts receivable balances on the sales ledger as collateral. When business owners use this method of finance, they can convert sales on credit into usable cash flow. The lender will utilize the outstanding accounts on the sales ledger to determine how much can be advanced at one time. Several factors, including the creditworthiness of the clients, can be considered by the lender when approving invoices for financing.

When companies choose this method of finance they will have quick access to cash. Lenders in the industry understand just how quickly their clients need usable cash and will generally process approvals for financing in as little as 24 hours once your account is set up. With the credit line comes no additional fees, no up-front costs, no facility fees, no audits, and no hidden rate hikes. This means that you will know exactly what finance charges you will be incurring when you accept the lender's offer.

Why is Accounts Receivable Financing Becoming So Popular?

Ever since the banking crash that led to a global recession, obtaining any type of commercial financing has become extremely difficult. Lenders offering commercial loans to small, mid-sized, and large businesses are asking for more than just business plans, profit and loss statements, and superior credit to extend offers for loans. Not only have approvals for business financing gone down in the United States, the amount of money a borrower can request has also dropped. This is in part because of the stricter lending requirements, and in part because of how risk is assessed by the lender.

Another reason why more and more businesses are choosing accounts receivable financing over other traditional alternatives is because of all of the fine print found in business credit card agreements. In the past, small business owners would apply for business credit cards that offered perks and low introductory interest rates. While some credit card providers do still offer these incentives, the applicant must have a nearly perfect credit score to be approved. In today's economy, even business owners are watching their credit scores drop. If you have been impacted by the global economic crisis, applying for a credit card simply might not be a practical option.

Accounts receivable financing is not only for businesses who are having difficulty getting approved for commercial loans and credit cards. Now, businesses who want to reduce their debt can generate capital by getting access to the money they have already earned in their receivables. By reducing the company's debts, you can increase shareholder interest and earn a larger market share in your industry. This will lead to what all business owners want, expansion. This is perhaps the biggest reason why accounts receivable financing is becoming such a practical and preferred alternative to traditional financing.

Keep Your Clients Happy and Still Get the Working Capital You Need to Expand Domestically or Globally

Companies offer to sell their products and services on credit for various reasons - one may be to keep their customers satisfied. With so many of your competitors offering their products and services on credit, you cannot reasonably require your customers to pay for their purchases in full if you believe in customer retention. But offering services and products on credit can be difficult for businesses who rely on their sales revenue to pay for upcoming expenses and merchandise.

According to surveys conducted in business-to-business industries, it takes the average customer between 40 and 60 days to pay for their purchases in full when they are buying on credit. If your company is relying on the payment of a large account to cover your own supplier invoices, you can see where this waiting period can become a very big issue. Requiring the customer to pay in full can lose you a sale, but failing to pay the suppliers and vendors can affect your reputation in the industry and your creditworthiness. When you choose accounts receivable financing, you can keep both your customers and your internal customers happy.

Frequently Asked Questions Regarding Accounts Receivable Financing

Now that you have a basic understanding of what invoice financing is and why it is becoming popular, you may have more detailed questions you want to ask. Before you choose this alternative form of asset-based lending, make sure all of your questions are answered so that you can make a sound decision for the financial health of your business. Here are some popular questions that business owners commonly want answers to before choosing invoice financing: also see frequently asked questions about factoring

What Types of Businesses Commonly Use Invoice Financing to Generate Capital?

It is important to keep in mind that not all businesses have the option to finance their invoices. Small businesses, mid-sized businesses, and even large corporations can all use invoice financing to their advantage if they are selling their products and their services on credit. Typically speaking, business-to-business companies are the best candidates for asset-based lending for invoice financing. This is because selling on credit is most common in the B2B sector because the credit decisions is leveraged on the account debtor, and they usually require some type of good credit rating found on dunn and bradstreet.

What Factors Can Affect How Much Interest You Pay?

When you are using the outstanding invoices on your sales ledger as collateral you have to assume that there is some risk to the lender. When it is more likely that a client will not pay the invoice, the lender will charge higher interest rates or make that specific client ineligible to submit. The lender has their own process of determining how risky specific accounts will be to collect. The lender may consider the amount of outstanding receivables, the number of customers, and how long these accounts have been outstanding. Obviously, the longer the accounts have gone unpaid, the more your fee or interest charges will be. Some lenders may also have minimum and maximum loan amounts that should be considered before you apply for financing.

How is Invoice Financing Different Than a Bank Loan?

The primary difference between bank loans and receivables-based funding is that the bank will consider your creditworthiness. When you receive invoice financing, the financing company will consider the creditworthiness of your customers instead. This type of funding is not technically considered a loan. Rather than borrowing from a financial institution, you are borrowing against your own balance sheet and reducing the debt on your balance sheet in the process. Because the requirements to obtain invoice financing are not as strict, it can take just a few days to receive the money you need.

Which Invoices Are Right to Use as Collateral?

As you might expect, not all of your customers are considered creditworthy to the lender. Just because you know that your customers are reliable does not mean that the lender is going to take your word for it. Generally, about 80 percent of your business will come from 20 percent of your customer base. If you are going to finance your invoices, it is best to choose accounts that are owed by the customers who do the most business with you. When a lender is approving a company or individual within your customer base, they will need the customer's name, address, phone number and amount of credit desired. You can finance up to 100 percent of your company's creditworthy accounts depending on the industry and the lender you choose.

Who Will Collect the Debt Owed on the Invoices?

When you are selling your accounts receivables to a lender at a discount, you might wonder who will attempt to collect the money due on the accounts. After all, you have already received an advance for the invoices you have sold. You will get peace of mind in knowing that the lender will handle the process of collecting on the accounts. This means that your employees can work on expanding the business instead of calling customers who have failed to pay what is due on time.

Accounts receivable financing has become a better alternative to traditional finance for businesses who cannot obtain loans. In today's economy, you need to make sure that you keep your clients happy while you still cover all of your expenses. Some business owners will rely on credit cards and commercial loans to cover their expenses. Wise business owners understand that avoiding debt at all costs is important. Do not dig your company into debt and turn your sales revenues that are on credit terms into working capital.

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