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Accounts Receivable Financing

Accounts receivable financing guide

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Two Ways to Finance Your Receivables

Are you a small business owner looking for a reliable and flexible financing solution? Have you heard about financing your accounts receivable but are unsure about how it works and whether it’s the right fit for your business?

In this article, we’ll help you understand the two forms of using your accounts receivables to generate cash for working capital.

Accounts Receivable Factoring

Accounts receivable factoring (or invoice factoring) is a form of business financing in which a business sells (or assigns) their accounts receivables, or invoices, to a third-party financial institution called a factoring company. The factoring company buys the invoices and pays the business a percentage of each invoice. The factoring company then assumes the responsibility of collecting the unpaid invoices.

Accounts Receivables Assignment

Assignment (or selling) of accounts receivables is the core component of accounts receivable factoring. It’s the legal transfer of ownership from your business to the factoring company. Most often, factoring companies receive assignment of all your accounts receivable, even those that you don’t factor.

The factoring company issues a notice of assignment (NOA) to your customer(s) that informs them of the accounts receivables assignment. This allows the factoring company to directly collect payments from your customers.

It’s essential to understand that the assignment of invoices is not a practice of selling your customers’ information or trust. It’s a transparent process so your customers make payments to the correct entity, protecting you, the factoring company, and your clients.

Factoring encompasses a broad range of services in addition to just buying invoices. Factoring companies perform the following services:

  • Verifying the accuracy of invoices
  • Monitoring your customers’ credit
  • Collecting payments from your customers
  • Providing an accounting of factored invoices

Factoring, in essence, is a partnership between a business and the factoring company dedicated to helping the business’s success.

This factoring process is covered by a agreement with a factoring company. The factoring agreement contains key details such as the advance rate, fee structure and other contractual obligations related to the sale of invoices.

Accounts Receivable Financing

Accounts receivable financing is a type of asset-based lending arrangement where a company uses its accounts receivables as collateral for a loan. The total accounts receivables balance is determined, and the receivable loan is based on a percentage of that value. The percentage can vary, but it is typically between 75% and 85%.

Account receivable loans are covered by a loan agreement with a receivables financing company. The receivable loan is set up as a revolving line of credit, but it can also be a simple term loan.

Accounts Receivables Collateral

Assessment of accounts receivables as collateral is the core component of accounts receivable financing. This involves evaluating the quality and quantity of the unpaid invoices. The accounts receivable lender will look at factors such as the age of the invoices, the creditworthiness of the clients, and the likelihood of payment.

This assessment is crucial as it determines the amount of loan that the business can secure. If the receivables are of high quality and the clients are likely to pay, the business can secure a larger loan. On the other hand, if the receivables are of low quality, the business may not be able to secure a loan or may get a smaller loan.

Once the assessment is complete, the business can proceed to secure the loan. This involves signing a loan agreement that stipulates the terms and conditions of the loan. The agreement will specify the amount of the loan, the interest rate, the repayment schedule, and the consequences of default.

Summary of Differences

Accounts receivable factoring is much easier and more practical for small businesses than accounts receivable financing.

Factoring is often a bridge to more traditional forms of financing such as accounts receivable financing.

 

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