Small businesses have long been fulfilling their financial requirement by taking out loans from banks. Through the economic slowdown, weak profit margins, poor cash to debt ratio, and stringent federal regulations have forced banks to take a more cautious approach while approving loans to businesses. The rejection rate of loan applications is rising steeply which is leaving business owners in a bind. In this situation, companies can benefit greatly from accounts receivable financing.
By using A/R financing, businesses get an opportunity to raise working capital without depending on a bank loan or other conventional sources of debt. Companies that bill their customers through receivables or invoices often wait 1-2 months before receiving payment. This can cause cash shortages to meet the ongoing operations expenses. If the cash flow problem becomes severe, business owners struggle to find a way to bring working capital into the business. This may lead to the company shutting down. To avoid taking such extreme steps, they could find a practical solution to their cash problems. A/R financing or invoice discounting is one such option.
When a company opts for account receivables financing or factoring, it is actually selling its outstanding invoices for instant cash flow. Instead of waiting for 15, 30, 45 or 60 days for their customers to pay on their invoices, they can generate cash flow in a few days (in 4 days). Factors are companies that buy receivables from a company looking for immediate funds. These invoices are purchased at a discounted rate, typically between 2.5% and 7.0%. The balance amount of the total fund is remitted after the factoring company collects the invoice amount from the customers.
A/R financing is quite useful for a business having a large volume of receivables. By working through a factoring company, it receives advances (usually from 40% to 90%) of an invoice. The factoring company assumes the responsibility for collecting invoice amounts from the business’s customers. From a broader perspective, A/R financing helps capitalizing on the growth potential of a business by providing a quick solution to the cash shortages.