Accounts Receivable Financing

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Accounts Receivable Financing

Definition

Accounts receivable (AR) financing is a way for a company to access cash by using outstanding customer invoices as the basis for financing. The arrangement can be structured either as an asset sale (factoring) or as a loan secured by receivables. AR are current assets on the balance sheet and are often considered when measuring liquidity (e.g., quick ratio).

How it works

  • A company that has billed customers but has not yet been paid converts some or all of those receivables into immediate cash.
  • Financiers evaluate the quality and age of invoices and then advance a percentage of the invoice value.
  • Depending on the structure, the financier may take responsibility for collections or the company may retain collections responsibility and simply repay an advance.

Common structures

Factoring (asset sale)

  • The company sells invoices to a factoring firm.
  • The factor typically advances a portion of the invoice value (often up to ~70–90%) and holds the remainder as a reserve.
  • When the invoice is paid by the customer, the factor returns the reserve minus fees.
  • The factor usually assumes collection responsibility and the risk of customer default (unless recourse factoring is used, where the seller retains some default risk).
  • Factors earn money through the spread (advance vs. final payout) and explicit fees.

AR-backed loan or line of credit

  • The company borrows against the value of its receivables; receivables remain on the company’s balance sheet.
  • Advances can approach 100% of an individual receivable in some arrangements, but the company must repay principal plus interest and fees.
  • Loans may be secured by invoices and can be structured as short-term advances or revolving lines tied to receivables.

Underwriting considerations

Factors and lenders typically assess:
– Creditworthiness of the invoiced customers (receivables owed by larger, creditworthy customers are more valuable)
– Age of receivables (newer invoices get better terms)
– Concentration risk (reliance on a small number of large customers)
– Industry and historical collection rates
– Integration with accounting systems (many providers link to QuickBooks, Xero, FreshBooks for faster underwriting and advances)

Advantages

  • Fast access to cash without the time and documentation of a traditional loan process.
  • Improves working capital and cash flow predictability.
  • With factoring (asset sale), the seller may offload collections and some default risk.
  • AR loans can provide advances without selling the asset and may allow full-value advances in some cases.

Disadvantages

  • Can be more expensive than traditional bank financing; fees and interest may be high.
  • Factoring reduces the overall value received for invoices due to spread and fees.
  • Potential reputational or customer relationship impacts if the financier handles collections.
  • Terms vary widely and may be less favorable for older, smaller, or higher-risk receivables.

Choosing between factoring and an AR loan

  • Use factoring if you want to outsource collections and transfer some default risk.
  • Use an AR-backed loan or line if you prefer to retain customer relationships and ownership of receivables.
  • Compare effective cost (fees + interest), advance rates, flexibility, and operational impact (integration, reporting, collections).

Examples of provider approaches

  • Some fintech providers integrate directly with accounting software to automate invoice verification and speed advances.
  • Examples of marketplace participants include traditional factors and newer fintech lenders that offer invoice advances or revolving lines of credit based on AR.

Key takeaways

  • AR financing converts unpaid invoices into immediate cash through factoring (asset sale) or AR-backed loans.
  • Terms depend heavily on the quality and age of receivables and the invoiced customers’ creditworthiness.
  • It’s a useful option for improving short-term liquidity but can be pricier than other financing methods; weigh costs, operational impacts, and whether you want to retain collections responsibility.