Most businesses have a regular need for working capital. Put simply, to keep your company healthy, you need to have the money to pay bills, cover operating costs and reinvest in business growth. That requires having sufficient working capital on hand. These days, many businesses are turning to accounts receivable financing in search of money. How does this system work? What benefits can it provide for your business?
What Are Accounts Receivable?
Your company’s receivables are its invoices that have been billed but not paid yet. The represent assets that belong to your business, but they’re tricky because you don’t actually have the cash in hand yet. This can cause issues with cash flow where you don’t have sufficient working capital to pay off your own suppliers.
That’s where accounts receivable financing comes into play. It’s a type of financing based on your unpaid invoices. It lets you get funding more quickly than normal.
How Does AR Financing Work?
AR financing works by allowing you to sell unpaid invoices to a lender, also known as a factor, in exchange for immediate payment. Sometimes, AR financing treats the transaction as a loan, but it’s usually a sale of assets for a cash advance.
Imagine that you have an unpaid invoice worth $1,000. Your business needs the money right away, but your client still has another 30–60 days to pay you. You decide to use this invoice for AR financing to solve your cash flow crisis. How would it work?
By factoring the invoice, you would sell it to the lender. Generally speaking, you would receive about 70% of the invoice’s value up front, or about $700. That amount is deposited in your bank account the same day.
The factor holds the other $300 until your customer pays off the invoice 30 or 60 days later. Once the invoice has been paid, you would receive the rest of the value, minus a small percentage.
What Are the Advantages of AR Financing?
There are several large benefits of AR financing. First, it’s fast. Once you open an account with the factoring company, you can process any invoices you want in roughly 24 hours.
Second, accounts receivable financing is flexible. You decide how much financing to get, when, and how to spend the money. That way, you can get an infusion of capital for buying computer equipment, taking care of payroll, purchasing inventory or handling emergencies.