Accounts Receivable Financing

Borrowing Against Receivables vs. Selling Them

Factoring and receivables lending are often lumped together, but they work differently. In factoring, you sell invoices to a factor, which usually notifies your customers and collects from them directly. With a receivables-backed loan, you borrow against invoices you still own and keep collecting them yourself.

Article 9 of the UCC covers both a security interest in accounts and an outright sale of accounts, so both involve UCC filings. The practical differences are control, cost and customer contact. A loan usually costs less and keeps your customer relationships unchanged, but it requires more reporting and a stronger overall credit profile. Factoring is easier to qualify for because the factor leans on your customers' credit, and it tends to cost more for the same dollars.

Industries Where It Works Well

• Staffing firms that pay workers weekly but bill clients on 30-day or longer terms.

• Distributors and wholesalers selling to retailers that take their time paying.

• Manufacturers waiting on large business customers with extended payment terms.

• Freight and logistics companies that carry fuel, payroll and equipment costs before shippers pay.

• Business services firms, such as IT, engineering and marketing providers, with recurring business-to-business invoices.

It is a poor fit for companies that sell mostly to consumers, bill on progress milestones that customers often dispute, or have a handful of invoices from slow-paying customers.

Frequently Asked Questions

Can a small business get accounts receivable financing through the SBA?
The SBA's CAPLines program, part of its 7(a) loan family, includes a Working CAPLine, which the agency describes as an asset-based revolving line of credit repaid by converting short-term assets into cash. It is offered through participating lenders, which set their own requirements within SBA rules.

Will my customers know?
With a loan structure, often not until the lender requires payments to go to a lockbox. Some lenders send notices or verify invoices directly with customers, so ask how they handle it before you sign.

Does my credit score matter?
It matters less than with an unsecured loan, but lenders still review the business's financial statements, tax filings, existing liens and the owners' background. Weak financials can usually be offset by strong receivables, up to a point.

How fast can I get funded?
Setup takes longer than later draws because the lender needs to review your aging, verify invoices and file its lien. Once the line is open, draws against new invoices can be quick.

Put Your Receivables to Work

If slow-paying customers are holding back your growth, the cash tied up in your receivables may be the most practical source of working capital you have. Review your aging, note which customers make up the largest balances, and compare accounts receivable financing offers on advance rate, eligibility rules and total cost.

Accounts receivable financing lets a business borrow against invoices its customers have not paid yet. Instead of waiting 30, 60 or 90 days for payment, you pledge those receivables as collateral, draw cash against them now, and repay the advance as customers settle their bills.

It is one of the most common forms of collateral-based credit because receivables are close to cash. A sound invoice owed by a creditworthy business customer only has to be collected, so lenders are willing to advance a large share of its face value. This page explains how the process works, which invoices qualify, and how to judge whether it fits your business.

How Receivables Turn Into Working Capital

Most receivables-based credit is set up as a revolving line. The flow looks like this:

1. You invoice customers as usual, on your normal terms.

2. You report your receivables to the lender, usually through an aging report that lists every open invoice by customer and by days outstanding.

3. The lender removes ineligible invoices and applies an advance rate to the rest. The result is how much you can draw.

4. You draw what you need, up to that amount and the line limit.

5. Customers pay, typically into a lockbox or a bank account controlled by the lender, and the payments reduce your balance.

6. New invoices replace paid ones, so availability keeps renewing as long as sales continue.

With a loan structure you still own the receivables, you keep handling collections, and your customers usually deal with you as before. The lender holds a security interest, which it perfects by filing a UCC-1 financing statement.

Which Invoices Count as Eligible

Lenders only advance against receivables they expect to collect in full. The OCC's handbook for bank examiners lists the characteristics commonly treated as ineligible, and most loan agreements follow a similar pattern:

• Aged invoices. An account is normally considered ineligible once it is past due by three times its terms, for example 90 days on 30-day terms.

• Cross-aged customers. If a set share of one customer's balance goes ineligible, all of that customer's invoices can be excluded.

• Affiliate receivables owed by related companies, because they can deteriorate together and carry higher fraud risk.

• Contra accounts, where you both buy from and sell to the same company, since it can offset what it owes you.

• Government receivables, which come with special assignment rules under the federal Assignment of Claims Act and often longer payment terms.

• Foreign receivables, which are often excluded unless backed by credit insurance or a letter of credit.

• Other exclusions such as unbilled work, re-aged invoices and amounts above concentration limits.

Example: From Aging Report to Availability

Here is how a hypothetical distributor's numbers might look on a single reporting date:

• Total open receivables: $600,000

• Less invoices more than 90 days old: $60,000

• Less balance owed by a sister company: $40,000

• Eligible receivables: $500,000

• Advance rate of 85 percent: $425,000 available to borrow

If the company has already drawn $300,000, it can draw another $125,000 that day. When a customer pays a $20,000 invoice, the loan balance drops by $20,000, and new eligible invoices add availability as they are issued.

What Lenders Study in Your Customer Base

With receivables, the lender is partly underwriting your customers. Three measures carry the most weight:

• Concentration. The OCC notes that banks normally consider receivables concentrated when a single account represents 10 percent or more of the total, and that lenders should limit concentrated accounts to no more than 10 to 20 percent of the receivables portion of the borrowing base, or lower the advance rate on them. If one customer makes up 40 percent of your sales, expect a cap or a lower advance rate on that account.

• Dilution. Returns, allowances, disputes and credit memos reduce what you actually collect. The same handbook says dilution is usually expected to be 5 percent or less of receivables, though it varies by industry. Higher dilution typically means a lower advance rate.

• Payment behavior. Lenders look at days sales outstanding, how often invoices slip past terms, and whether major customers have been paying more slowly.