Reasons to Use Accounts Receivable Financing, and When Not To

How accounts receivable financing works

A finance company advances a percentage of your open invoices. When customers pay, you repay the advance plus fees, and the provider releases any remaining balance.

Say you invoice a customer $50,000 on net-45 terms. A provider may advance a portion of that amount quickly, for example 80 percent, and charge a fee based on the time the invoice stays open. When the customer pays, the provider takes its advance and fees and sends you the rest. Terms and rates vary by provider.

There are two main structures. In one, you borrow against receivables as collateral and keep collecting from customers yourself. In factoring, a company buys your invoices and often collects directly from your customers. Read more in what is accounts receivable and understanding invoice factoring.

Good reasons businesses use it

The strongest reasons are slow-paying commercial customers, growth that outpaces cash, seasonal swings and a need for money that scales with sales.

• Slow-paying customers. Business-to-business sellers often wait 30 to 90 days. Financing covers the gap.
• Payroll and supplier bills that cannot wait. Staffing firms, contractors and distributors pay out weekly while clients pay monthly.
• Growth. A big new contract means buying materials and hiring before the first payment arrives.
• Seasonality. Cash comes late in the cycle while costs come early.
• Limited collateral. The invoices themselves support the funding, which helps firms without real estate or equipment.
• Funding that scales. More invoices can mean more available cash without a new application each time.

What it costs

Fees are typically charged per week or month an invoice is open, and can add up. Calculate the total fee as a percentage of the invoice, then compare it with the job's profit.

Illustrative example: a $50,000 invoice is financed for 45 days at a fee of 1 percent per 15 days. That is 3 percent, or $1,500. If the job produces $12,000 in profit that you could not have taken without the cash, the fee is easy to justify. If the job's margin is 4 percent, or $2,000, the $1,500 fee eats most of the profit.

Watch for extra charges such as setup fees, minimum volumes, monthly minimums and reserve holds. Use the factor rate calculator and read how factor rates work to compare quotes.

Risks and downsides

Costs can reduce thin margins, customers may learn you use financing, and some contracts require you to finance all invoices or buy back unpaid ones.

• Fees can stack up when customers pay late.
• In some structures, the provider contacts your customers directly, which changes the relationship.
• Recourse terms may require you to repay if the customer does not pay.
• Contracts may include minimum volumes or long commitments.
• Concentration in one customer can limit what the provider will advance.
• It does not fix a business that is unprofitable. It only moves cash forward.

Read the whole agreement before you sign, and ask about termination. Compare with line of credit vs. invoice financing.

Where ROI Funder fits, and where it does not

ROI Funder does not place accounts receivable financing or invoice factoring. For the same problem, a business line of credit or working capital is the closest fit.

If your goal is to bridge a gap until customers pay, ROI Funder can help in other ways:

• Business line of credit. Draw while you wait on invoices and repay when they clear. Decisions in 24-72 hours.
• Working capital. A lump sum for operating costs, funded the same business day on approved, complete files.
• Revenue-based financing. Repayment rises and falls with sales.

When is ROI Funder not a fit? If you want an advance that is sized strictly to specific invoices, or your business does not meet 500+ FICO, 6+ months in business and $20,000+ monthly revenue, a dedicated receivables provider may suit you better. For product detail, see accounts receivable financing and invoice factoring.

Alternatives that reduce your need for it

Faster invoicing, deposits, shorter terms, early-pay discounts and active collections can shrink the gap before you borrow.

Often the cheapest financing is a better payment process:

1. Send invoices the day work is complete. See send invoices that get paid faster.
2. Collect a deposit or milestone payments on large jobs.
3. Offer a small discount for early payment.
4. Follow up on a schedule. Tips for collecting unpaid invoices shows how.
5. Run credit checks on new commercial customers.

Use outside funding after you have tightened the process, so you pay for timing gaps rather than for habits.