What Is Accounts Receivable Financing?

Economic uncertainty, inflation and pandemic-related disruptions have meant that many enterprises are leveraging strategies to retain as much working capital as possible. For suppliers, this often results in lengthy payment terms, which can quickly reduce cash flow and affect business continuity and growth.

While working capital research suggests that payment timelines are starting to decrease — good news for suppliers — waiting 60 or more days for customer invoices to clear accounts receivable is still common. Rather than relying on a traditional business loan to bridge these cash gaps, you might consider accounts receivable financing to ensure sufficient cash flow.

What is accounts receivable financing?

A business’s accounts receivable are its unpaid invoices — money that customers still owe you for goods and services purchased. Accounts receivable financing is an agreement that finances a business based on its accounts receivable assets. 

Businesses that invoice customers rather than receive upfront payments are normally required to wait to receive cash from sales. For some businesses, these payment terms may exceed 30, 60 or 90 days. By financing accounts receivable assets, businesses can access cash sooner — capital that would otherwise remain unusable until customers settle payments.

Accounts receivable financing agreements can be structured in three main ways:

• Factoring or asset sales. In these arrangements, a financier — sometimes called a “factor” — purchases your outstanding invoices. You are advanced a portion of the accounts receivable asset value, typically between 70% to 90%. The financier is then responsible for collecting payment in full from the customer. Once the financier has received payment, it gives you the remaining invoice value minus fees. Factors often charge fees based on how long it takes to collect payments. 
• Asset-based loans. Rather than selling invoices to a factor, you can use your accounts receivable assets to secure a loan. In this scenario, a lender funds your business based on your accounts receivable balances. Depending on the loan terms, the funding may be secured by your accounts receivable. This means that if you fail to repay the loan, the lender can claim your accounts receivable as collateral. As with other types of loans, you must repay an asset-based loan with interest and fees.
• Invoice discounts. Alternatively, you can “finance” your accounts receivable by offering customers small discounts for early payment. These discounts essentially enable you to fund early payment yourself, excluding any third-party financiers. Traditionally, early payment discounts are offered as a fixed percentage if the customer pays within a set time frame. More modern approaches express discounts as an annualized percentage rate (APR) and determine the discount based on how early the customer pays.

Accounts receivable financing can be used by any business that needs to accelerate cash flow. However, it’s particularly valuable for small to midsize suppliers that lack working capital, have lengthy customer payment terms or struggle to obtain other types of business financing. Because accounts receivable are viewed as highly liquid assets, securing financing is often easier for smaller businesses than getting other types of loans. 

Benefits of accounts receivable financing

The biggest benefit of accounts receivable financing is that it gives your business prompt access to cash. Waiting extended periods for invoices to clear accounts receivable can quickly deplete the working capital needed to fund business operations. Even though working capital financing will cost you — whether it’s in the form of fees, interest or invoice discounts — the cost is often worth the cash flow boost. Having faster access to the cash you’ve earned not only keeps your business operating smoothly but also can fund growth and improve core business metrics such as days sales outstanding and the cash conversion cycle. 

Working capital financing is known for being more immediate and accessible than business loans offered through a bank. Depending on the solution, it can even be more affordable. Working capital financing will also save your business time and resources spent chasing customers for payments. Additionally, this type of financing has the potential to strengthen customer relationships. For example, invoice discounting also benefits your customers’ bottom line by reducing their cost of goods sold. With sufficient cash flow, your business can reliably fulfill orders on time and in full, and make growth investments to meet evolving customer demands.

Accounts receivable financing solutions

While some banks provide accounts receivable financing, it is most commonly offered by fintech companies and online lenders. However, not all accounts receivable financing solutions are created equal. 

Factoring companies are often associated with inefficient processes, confusing contracts and hidden fees. Because the factor owns the payment collection processes after you’ve sold an invoice, you also lose control over that part of your customer relationships. Depending on the contract, you may also be required to sell all of your accounts receivable. If you’re pursuing invoice factoring, make sure you understand the agreement’s terms and conditions as well as the interest and fees involved. 

Businesses that want a cost-effective solution and the ability to choose which accounts receivable to finance often opt for early payment programs. These programs make invoice discounts easy to implement. They also function as effective working capital solutions, either on their own or in conjunction with other financing. For example, here’s how it works with C2FO’s Early Pay solution:

1. Your participating customers automatically submit outstanding invoices to an online portal.
2. You choose which invoices to accelerate and determine an acceptable discount rate. 
3. If approved by the customer, you receive payment minus the discount in as little as 24 hours.

The bottom line

In simple terms, accounts receivable financing allows you to unlock cash from unpaid invoices rather than waiting the full term to receive customer payments. Freeing up earnings trapped in accounts receivable is an effective way to build cash flow, grow your business, navigate economic uncertainty and fund business operations when payment terms are extended.

A variety of solutions have emerged to help businesses address liquidity issues related to their accounts receivable. If you’re seeking a working capital solution, consider innovative fintech companies that specialize in accounts receivable financing or invoice discounting.

Need to accelerate invoices and build cash flow? Learn more about C2FO’s working capital solutions for suppliers.