Accounts receivable (AR) is the amount of money that a company is supposed to receive from its customers in lieu of goods/services sold. It forms a significant part of the balance sheet, and companies depend heavily on their AR conversion for cash flow. However, payments may get delayed. So, if a business needs cash urgently, it can choose to finance its accounts receivable.
Accounts receivable financing is a provision businesses have to raise capital by placing their pending AR as collateral. It is beneficial when businesses need capital and cannot secure a bank loan. There is a small fee involved that the financer charges in this arrangement.
Suppose Company A gets an order to produce 200,000 pillow covers for $500,000. However, it needs $300,000 in capital to fulfil the consignment. So, it can either take a loan from the bank or get a third party to finance up to 90% of the invoice keeping it as collateral.
Once the order is fulfilled by company A with the money it received from the third-party, it is expected to collect the payment from its customer. Then it will pay the third party the financed amount and the agreed-upon fee.
There are two primary types of accounts receivable financing:
|1) It is faster than taking a traditional loan from the bank. It usually takes less than a day for the process to be completed.||It can be expensive depending on the quality of the invoices, the industry you are in, and the third-party financier.|
|2) AR financing involves keeping your pending invoice as collateral. It doesn’t require your business to have a good credit history.||The ability to finance your invoice will be dependent on the customer. So, if your customer doesn’t have a good credit history, the financing fee might be high, or you won’t be able to finance the AR at all.|
|3) Companies can pass on their collection efforts to a third-party company called a factor, who will collect the payments for them in exchange for a fee.||Companies lose control of how the third-party financier interacts with the client while collecting the payment, which could ruin business relationships.|
|4) There is no need to give other assets as collateral to get the cash.||If the customer doesn’t pay, the business will be responsible for that.|
Businesses can choose Invoice discounting when they do not want to give control over their invoices and customer interactions. On the other hand, factoring is a good option for companies if they want to outsource the collections process.
When choosing a financing company, it is crucial to check how much the arrangement costs you. The charges can be as high as 3% per week if your customer doesn’t pay. So, it could eat up a significant portion of your AR.
It is also essential to check the track record of the financing company on how they deal with customers if you choose factoring. That’s because if they handle the customers in an impolite way, they might churn.
Check out our articles on accounts receivables:
What is Accounts Receivable Factoring [Examples & Benefits]
Understanding Days Sales Outstanding & Its Role in Optimizing AR
AR financing is money that’s obtained by selling an invoice or using it as collateral to fulfil the order placed by a customer. On the other hand, inventory financing is when a business raises funds by pledging some or all of its stock as collateral.
In AR financing, the control of the invoice stays with the business, and they are responsible for collecting the payment, whereas in factoring, the third party is responsible for the same.
Automate invoicing, collections, deduction, and credit risk management with our AI-powered AR suite and experience enhanced cash flow and lower DSO & bad debtTalk to our experts
The HighRadius RadiusOne AR Suite is a complete accounts receivable’s solution designed for mid-sized businesses to put their order-to-cash on auto-pilot with AI-powered solutions. It leverages automation to fast-track key accounts receivable functions including eInvoicing & Collections, Cash Reconciliation, and Credit Risk Management powered by RadiusOne AR Apps to improve productivity, maximize working capital, and enable faster cash conversion. Affordable, quick to deploy, and functionality-rich: it is pre-loaded with industry-specific best-practices and ready-to-plug with popular ERPs such as NetSuite and Sage Intacct. The HighRadius RadiusOne AR Suite is designed to automate labor-intensive processes while streamlining credit and collections activities for faster AR processing, better cash flow and improved profitability.