What is Accounts Receivable (AR) Financing?
Accounts receivable financing allows companies to receive early payment on their outstanding invoices. A company using accounts receivable financing commits some, or all, of its outstanding invoices to a funder for early payment, in return for a fee.
What are the three primary types of receivables finance?
- Asset-based lending (ABL): Also known as a business line of credit or traditional commercial lending, asset-based lending is an on-balance sheet technique and typically comes with significant fees. Companies commit the majority of their receivables to the program and have limited flexibility about which receivables are committed.
- Traditional factoring: In factoring, different than reverse factoring, a business sells its accounts receivable to a funder – but the initial payment is for less than the full amount of the receivable. For example, a company may receive early payment for 80 percent of the invoice amount minus processing fees. Compared to asset-based lending, companies have more flexibility in choosing which receivables to trade, but funder fees can be high and credit lines may be smaller. As with ABL, any factored receivables are recorded on the company’s balance sheet as outstanding debt.
- Selective receivables finance: Selective accounts receivables finance allows companies to pick and choose which receivables to advance for early payment. Additionally, selective receivables finance enables companies to secure advanced payment for the full amount of each receivable. Financing rates are typically lower than other alternatives, and this method may not count as debt based on the program structure. Because selective receivables finance stays off the balance sheet, it does not impact debt ratios or other outstanding lines of credit.
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Why is Selective Receivables Finance Often a Preferred Option?
Compared to asset-based lending and traditional factoring, selective receivables finance delivers cash flow gains more efficiently and often at lower costs and risks. Here’s why:
- Not counted as debt: When structured properly, selective receivables finance stays off a company’s balance sheet and therefore has no impact on outstanding loans or future requirements for lines of credit and similar funding.
- Companies choose which receivables are paid early: Companies can choose which receivables they want to submit for early payment rather than offer up their entire rolling book of receivables. As a result, they can more closely control their ability to trade off cash flow gains and funding costs.
- Flexibility to choose when to participate: Selective receivables finance allows companies to participate only when they need to. This is key for businesses that experience seasonal demand or during periods of economic volatility.
- Ability to tap into multiple funding sources: Unlike other options, selective receivables finance allows companies to incorporate multiple funders into a program. This reduces the risks inherent in relying on a single financial institution (including when a bank will restrict liquidity due to changes in their own circumstances).
- More favorable pricing: By incorporating multiple funding sources, selective receivables finance enhances price competition.
How Does Selective Receivables Finance Work?
The most successful selective receivables finance programs are powered by state-of-the-art software platforms that allow companies to sell their invoices for early payment well before the actual due date and, in most cases, without any involvement from or disclosure to their customers. Facilitating a true sale of receivables, not factoring or a loan, the platform automatically handles all transactions across multiple customers and provides companies with additional cash flow in different countries and currencies.