What is 'Accounts Receivable Financing'

Accounts receivable financing is a type of asset-financing arrangement in which a company uses its receivables — outstanding invoices or money owed by customers — as collateral in a financing agreement. In this agreement, an accounts receivables financing company, also called a factoring company, gives the original company an amount equal to a reduced value of the unpaid invoices or receivables.

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 financing company.

BREAKING DOWN 'Accounts Receivable Financing'

Accounts receivables financing companies typically advance companies 70 to 90% of the value of their outstanding invoices. Then, the factoring company collects the debts and pays the original company the remainder of the amount collected minus a factoring fee.

How Factoring Companies Price Accounts Receivables

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. Similarly, new invoices are more valuable than old 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.

How Accounts Receivable Financing Helps Companies

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

In addition to providing a unique financing option for businesses, factoring companies also offer other services. These accounting-centered services include running credit checks on new clients and generating financial reports.

Negative Perceptions Associated With Factoring

Although factoring offers a number of diverse advantages, it sometimes carries negative connotations. In particular, financing through factoring companies typically costs more than financing through traditional lenders such as banks. As a result, businesses who turn to factoring companies are sometimes perceived to have poor credit or to being failing financially in other ways. However, analysts in the industry claim these misgivings are not founded on reality, and they state all manner of upwardly mobile, successful companies use accounts receivables financing as needed.

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