What is Receivables Financing?

Chances are you’ve heard of accounts payable and accounts receivable; you might also be familiar with the term “receivables financing”, but not know exactly what it is or how it works. If that’s the case, you’re in the right place.

To avoid any confusion, let’s start by reviewing some basic accounting terms. Accounts payable is the money that a business owes, usually to its supplier. Accounts receivable is the money a business is owed, usually by its customers. 

Receivables financing is when a business gets paid early for invoices they have issued in their accounts receivable. In other words, a business’s client has made a purchase but has not yet transferred the money. There will be an invoice connected to the transaction, and based on these types of invoices, a company will have different accounts receivable financing options.

Let’s look at an example to help clarify. 

A business that sells wood to construction companies gets an order for $500,000. The construction company needs supplies immediately, but won’t have the funds to finish paying off the order for six months. The wood business agrees to the terms of the deal, supplies the wood, and issues an invoice for $500,000 to be paid off in six months.

Sounds great! But what happens if five other construction companies make similar orders with similar payment terms? If the wood company isn’t making money from its sales until months after the fact, it will run into some serious cash flow issues. 

Enter receivables financing!

An invoicing factoring company can look at the invoices in the wood company’s accounts receivable and advance them some of the money they are due to receive so they’re not stuck without cash for months. Once the wood company gets paid by the construction companies, they can repay the factoring company, plus fees. 

The construction company gets wood, the wood company makes the sale, and the factoring company gets the fees. Everyone is happy. 

 

How receivables financing works

Now that you get the gist of what receivables finance is, let’s dive into how accounts receivable financing works. 

A company can apply for receivables financing with an invoice factoring company by sending them all of their invoices and any other required documents. 

Depending on different factors like the company’s credibility and industry, the lender usually funds some or all of their accounts receivable. 

The business can then use this money for business expenses like payroll, rent, and other immediate purchases. They will then pay the lender a weekly or monthly fee until the money is fully paid off. 

 

What are the three primary types of receivable finance?

 

• Asset-based lending 

ABL is when a company commits most of its receivables to the lender in exchange for a set business line of credit. This type of receivables financing is usually not very flexible and often has high fees.

 

• Traditional factoring

Traditional factoring is when a business receives early payment for less than the full amount of invoices in their accounts receivable minus fees. This type of receivable finance is usually more flexible than ABL but can also have high fees. 

 

• Selective receivables finance

The most flexible of the three, selective receivables finance allows businesses to choose which of their receivables they would like to get paid early for. Unlike the other two types, selective receivables finance is not recorded on the balance sheet, meaning it does not have an impact on a company’s debt or credit. 

 

The benefits of receivables finance  

Receivables financing is a great way for businesses to get funds without having to pursue more complicated routes like loans. Businesses don’t have time to wait and receivables finance is a solution to getting cash fast.