There are hundreds of accounts receivable financing companies offering to help businesses small and large free up working capital. With so many out there, how do you choose?
Accounts receivable financing (sometimes called invoice financing, receivable factoring, or accounts receivable funding) puts cash in your hands while you wait for your customers to pay their invoices. Chosen wisely, this type of financing can be a powerful aid to your business, helping you drastically increase cash flow while ensuring customers pay their bills on time.
But not all accounts receivable financing companies are transparent about their fees and terms, and some of them can be more hindrance than help—souring your relationships with clients and cutting into your bottom line.
This article gives you the tools you need to understand the different types of accounts receivable financing, and to choose the best company to serve your needs.
An AR financing company is a lender, and AR financing is a kind of asset-based lending. They lend you a portion (almost always a majority) of the value of an unpaid invoice. Once your customer or client pays the invoice, you pay back the loan, along with fees for the service.
Since it’s rare for customers to pay invoices the moment they receive them, businesses are often left waiting to get paid. Sometimes, longer net terms—net 60 or 90—can help attract larger customers. The trade-off is larger gaps in the billing cycle, as vendors effectively act as lines of credit for their clients. Customers push net terms to their limits, while vendors watch their AR go up and their cash accounts shrink, struggling to keep their balance sheet in line.
AR services solve cash flow problems for small businesses, as well as larger companies, to cover expenses—even if customers take their sweet time paying invoices. They can save businesses from being forced to take out bank loans or pursue more costly means of freeing up cash flow.
The cash advances provided by these financing solutions are especially helpful during times of rapid business growth, when you may be pursuing new business opportunities and need money in your bank account ASAP.
Many companies new to this type of business financing consider engaging an invoice factoring company to solve their cash flow woes. While invoice factoring is a good choice for some businesses—typically larger ones, with a high volume of sales—it comes with a number of drawbacks.
In effect, an invoice factoring company purchases your outstanding invoices as assets. You get a percentage of the value of the invoice up front, and the factoring company gets the right to collect on the invoice. Once they collect the full amount, the company sends you the remainder of the value of the invoice, minus the interest and fees they charge for their service.
When a small business owner hires an invoice factoring company, they outsource their accounts receivable to that company. It becomes their job to collect payments from customers.
The benefit of invoice factoring is that you increase your cash flow. Also, you no longer have to worry about following up with clients to make sure they pay on time, or chasing down customers who don’t pay their bills. But there are drawbacks:
Loss of control. The invoice factoring company owns your accounts payable. Each company has its own terms—for instance, how much they pay you up front for each invoice, and how much they charge you in fees—but, outside of those terms, it’s up to them to administer your accounts receivable as they see fit.
Potential to sour relationships with customers. The invoice factoring company serves as your business’s public face when dealing with clients. If they use aggressive collections strategies to resolve late payments, or run credit checks that damage your customers’ credit ratings, it could reflect poorly on your company. It could even cost you customers.
Steep discounts on the cost of invoices. To cover their fees, factoring companies often charge a discount as high as 10 – 20% on the value of invoices—meaning, you ultimately receive just 80% of an invoice’s value. On top of that, fee structures may be opaque or complicated, making it hard to anticipate the factoring company’s cut. It’s up to business owners to decide whether revenue losses of 10 – 20% are worth the extra liquidity provided by invoice factoring companies.
Luckily, invoice factoring isn’t the only option for companies aiming to speed up their AR cycle.
Discount financing companies are similar to invoice factoring companies in some ways. For instance, with discount financing, your company:
- Gets a portion of an invoice’s value up front, and receives the full amount later
- Pays interest and fees to the discount financing company
- Increases cash flow and shortens the A/R cycle
That’s where the similarities end.
Rather than selling outstanding invoices to a third party, your company receives a small business loan for a percentage of each invoice’s total value. Once your client pays an invoice, you pay back the discount financing company for the loan.
As a result, your AR processes never leave your control. It’s up to you to collect from clients and follow up on overdue invoices.
That leaves you more work to do, but it also means you have control over how you interface with clients—you decide when to follow up with them, and when to send accounts to collections.
Discount financing companies typically receive a smaller discount on invoices—maxing out at around 10%, in most cases—than invoice factoring companies.
If you’re researching A/R financing options, you may come across reverse factoring. This service helps buyers obtain goods and services on credit. You can learn more from our introduction to reverse factoring.
Resolve is the complete solution for companies’ net terms woes.
Companies can take advantage of 50%, 75%, or 90% Advance Pay options from Resolve, closing up gaps in their accounts receivables. Customers are able to pay their invoices on deferred terms and view their account histories through Resolve’s white-label portal, branded with the company logo.
Resolve handles all follow-up and collections on unpaid and late invoices, without compromising companies’ relationships with their clients.
There are many, many AR financing companies making their services available to businesses. And there are many lists and rankings of AR companies published every year—some of which are sponsored by the AR companies themselves.
Ultimately, it’s up to you to make the best decision for your business. Only you understand your particular challenges, needs, and goals for the future.
As you consider different AR financing options—whether invoice factoring, or discount financing—there are a lot of angles to consider. Below, you’ll find the five most important criteria to keep in mind.
When you work with an AR financing company, your company’s cash flow is directly affected by how long it takes them to approve invoices and customers.
For instance, if the invoice factoring company you’ve hired takes three to four days to approve every invoice you submit, that’s an extra three to four day gap in your AR cycle. That’s significantly shorter than if you didn’t use any AR financing at all, but you still need to take it into account when you plan how you will cover business expenses.
The application process for new customers can also slow cash flow down. The AR financing company needs to check the creditworthiness of each new customer. If your company is growing fast, that could result in a delay every time a new customer wants to open a credit account.
When considering AR financing, make sure you’re 100% clear on what to expect in terms of delays, and how it will affect your cash flow if you decide to sign up. For instance, will you receive the cash in one business day or less?
How your outstanding invoices are handled will depend on whether you use a discount financing service (which leaves invoice follow-up in your hands) or an invoice factoring service (which takes ownership of your accounts receivable and handles invoice followup for you.)
Ask yourself two questions:
- Is collecting on invoices currently a major drain on your company? Do you want to be freed from the responsibility of sending reminders, following up on late invoices, etc.?
- Are you comfortable with a third party handling your invoices?
If your answer to #1 is “yes” and your answer to #2 is “no,” you may find yourself in a difficult position. It will be up to you to thoroughly research how prospective AR financing services would interact with your customers. The pushy collections tactics used by some invoice factoring companies have the potential to sour relationships with clients.
What kind of credit checks does the AR financing company you’re considering run? Invasive credit checks may lower customers’ credit ratings and hinder your ability to build a healthy, long-term customer-vendor relationship.
Try to find an AR financing company that uses “soft checks” to qualify customers without damaging their credit scores. Resolve uses proprietary algorithms and financial databases to approve new customers without adverse effects (and even offers free business credit checks).
Not all AR financing companies are clear about the fees they charge.
Make sure you understand:
- How much you must pay as a monthly flat rate to use the service
- How much (in percentage points) you’ll be required to pay for each payment
- The advance rate and the net terms to which #2 applies
The third item on this list is important. Different advance rates may come with different fees; you can expect an advance of 90%, for instance, to cost more (in percentage points) than an advance of 75%.
Likewise, net terms will differ in pricing. Longer net terms—net 60 as opposed to net 30, for instance—typically come with a higher price.
An AR financing company’s rate may look much better than the competitors—until you read the fine print, and realize it applies only to 50% advances with net 30 terms. Any company you seriously consider should be upfront about the cost of A/R financing.
Finally, in the event you sign up with an AR financing company, how will your customers be able to pay their invoices?
This goes beyond B2B payment processing options (although those are important—the more, the better!) It also has to do with customer experience. When they pay, will your customer be routed through the interface for a third party they’ve never heard of? Will your AR financing company’s identity be front and center, or will your own brand? How trustworthy will the experience feel?
New clients of invoice factoring services sometimes field complaints from long-time customers who are taken aback by the switch to a third party service. It’s important that, however your customers pay you, they feel they can trust the process. As a side note, Resolve gives you a payment portal branded in your company’s style, so customers never need to worry about who they’re paying.
These five tactics are meant to get you started on your journey. Before you make a final decision, check out Resolve’s complete guide to accounts receivable financing.