The Pros & Cons of Trade Receivables Financing

What is Accounts Receivable Financing?

A deal in which a company borrows money depending on the quality and quantity of its accounts receivables is known as accounts receivable financing or trade receivables financing. Because "accounts receivable" refers to a company's overdue bills, it's also known as invoice finance.

Factoring vs. Account receivable Financing

There are two methods to organize accounts receivable finance. Invoice (or accounts receivable) financing is the first, and invoice (or accounts receivable) "factoring" is the second.

You sell your outstanding invoices to a factoring business in exchange for a cash advance via invoice factoring. When your clients pay, you'll get the remainder of the invoice minus a factoring charge. Your invoice payments are collected directly by the firm to which you sell your invoices.

The Pros of Accounts Receivable Financing

1. Fast funding

Accounts receivable finance, regardless of how it's structured, is one of the easiest methods to get more working capital. You might have your money in as little as 24 hours, depending on the loan institution you choose.

Invoice finance is a wonderful way to handle short-term cash flow concerns because of the rapidity with which it may be funded.

2. Minimal credit requirements

When it comes to invoice financing or factoring, the quality of your invoices is most important to the finance firm. Your credit score isn't a decisive factor if your clients have good credit and pay on time. This is because your invoices act as security, and the lender's risk is that your customers may default on their payments.

As a result, if you can demonstrate that you have dependable clients, you can get invoice financing even if your credit history isn't perfect.

3. Ability to outsource collection

As previously said, invoice factoring entails the factoring business collecting payments on your behalf. This relieves many enterprises of a significant administrative load. Keep in mind, however, that this is only true for invoice factoring.

You'll still have to collect invoice payments if you use invoice financing.

The Cons of Accounts Receivable Financing

1. Can Be Costly

Fee arrangements for accounts receivable financing may quickly become convoluted and costly. The rate you pay is determined by the following factors:

The total number of invoices and the average invoice amount.

The industry in which your business operates

Creditworthiness and payment history of your consumers

The typical factoring cost, according to NerdWallet, ranges from one to five percent, based on the parameters listed above.

2. Lack of control

While some business owners like the convenience of outsourcing payment collection to factoring organizations, others may be concerned about losing control. After all, collecting payment is a crucial - and sometimes delicate - aspect of your customer's experience. If you opt to factor your bills, you relinquish control over an important aspect of your consumers' interactions with your business.

3. Dependency on customers

One of the most significant advantages and disadvantages of invoice financing is its reliance on your customers. On the one hand, unlike other forms of financing, your prospects of being accepted aren't as reliant on your credit history.

On the other hand, approval may be difficult if your consumers have weak credit ratings or a shaky payment history. Furthermore, if you are approved, you will be charged a larger factoring cost. You may be charged even more if your clients pay late, on top of the increased basic rate.

How to Apply for Account Receivable Financing

You must fill out an application to apply for trade receivable financing or factoring. You'll also be requested to provide bank account statements and accounting records that demonstrate your anticipated earnings.

You submit unpaid bills after you've been accepted. The factoring business will then approve your invoices and either issue a line of credit for you or give you an advance.