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Accounts receivable financing is an alternative to a traditional business loan. AR financing is typically used by companies that are not currently bankable or for startups that lack collateral. It is a good option for businesses that need immediate capital for projects or those that are reliant on outstanding customer payments. They can be a quick way to keep day to day operations running. Although similar to factoring, accounts receivable financing is quite different (you can learn more about how the two compare here). This buying guide explains what you need to know about account receivable financing, including how much it costs.
To secure capital for your business through accounts receivable funding, the following steps are typically involved:
- After deciding that you either don't qualify for a bank loan or can't wait up to 90 days to be paid by your customers it's time to reach out to a factoring company (also known as a "factor").
- You present the factor with your accounts receivable invoices (the money owed to you by other companies). They will then decide if it's willing to lend you money against any of them, with the accounts receivable essentially acting as collateral. Note, however, that factoring companies must consider the entity underlying an invoice to be creditworthy before it will lend you money against the amount owed. Other criteria including minimum monthly sales may also apply.
- After the factor has selected qualified receivables it lends you a percentage of their total value. This is generally around 75% to 85% of the total. Then, you pay interest on the amount borrowed. Note however, that under an accounts receivable financing agreement that you are still responsible for collecting money from your clients. This is unlike a factoring contract where the factor requests payments from clients. On the plus side, because you're doing more work, the borrowing fee is usually lower than with factoring. But, if you default on the loan then the lender takes control of your accounts receivables and collects the debt themselves.
An example of when a company might borrow money through financing receivables is if a small business wants to bid on a contract, but doesn't have the funds available to complete the project. Knowing that they can use receivable financing once it wins the contract, they free to bid.
Accounts Receivable Financing Average Costs
Accounts receivable financing generally costs about 1% to 5% of the actual amount borrowed.
However, that depends on the industry you're in. The collateral management fee can vary as can the total amount of money provided up front. Individual lenders may also impose set up fees, invoice validation charges, and other costs.