What is Accounts Receivable Financing?

Accounts receivable financing is a type of asset-financing arrangement in which a company receives immediate financing by transferring its receivables—outstanding invoices or money owed by customers—to a factoring company. The age of receivables largely impacts the amount of financing the company receives.

Understanding Accounts Receivable Financing

In a typical accounts receivable financing arrangement, the company receives payment immediately that is equal to a reduced value of their receivables balance. Factoring companies typically advance businesses 70 to 90 percent of the value of their outstanding invoices. This type of financing helps companies free up capital that is stuck in unpaid debts.

Accounts receivable financing also transfers the default risk associated with the accounts receivables to the factoring company. The factoring company pursues payments from the original company's customers and collects the debts. It then pays the original company any remaining amount received beyond the financing percentage, minus a factoring fee.

Factoring companies take several elements into account when determining how much to offer a company in exchange for its accounts receivables. In most cases, accounts receivables owed by large companies or corporations are more valuable than invoices owed by small companies or individuals, as there is a higher chance of it being paid in full. Similarly, newer invoices are more valuable than older invoices. Generally, the easier the factoring company feels a bill is to collect, the more valuable it is, and the harder a bill is to collect, the less it is worth.

Advantages and Disadvantages of Accounts Receivable Financing

This type of asset-based financing allows companies to get instant access to working capital without jumping through the hoops or dealing with the long waits associated with getting a business loan. When a company leverages its accounts receivables to boost its cash flow, it also does not have to worry about repayment schedules. Instead of focusing efforts on trying to collect bills, the company can focus on other core aspects of its business.

Although factoring offers a number of diverse advantages, it also can carry a negative connotation. In particular, financing through factoring companies typically costs more than financing through traditional lenders. As a result, businesses that turn to factoring companies are sometimes perceived as having poor credit. However, industry analysts claim these misgivings are not founded on reality. They state that numerous upwardly mobile, successful businesses use accounts receivables financing when needed.