How to Finance Accounts Receivable and Inventory

Companies that want to finance receivables do so because they can’t afford to wait up to 60 days to get paid by their clients. Financing their receivables allows them to improve cash flow relatively quickly.

However, companies that look for inventory financing may be trying to solve two very different problems. On one hand, there are companies that need funds to pay suppliers so that they can build inventory. On the other hand, there are companies that have funds tied in excess inventory and need to access those funds. These two problems require two very different solutions.

We are going to discuss four alternatives that can be used to finance these situations: Accounts receivable financing, inventory financing, supplier financing, and asset-based lending.

Option #1: Accounts receivable financing

Selling products and services on net-30 terms can create problems for companies, especially those that don’t have a sufficient cash reserve. These terms can restrict your ability to run the business effectively. A cash flow crunch can prevent you from paying suppliers and other important expenses in a timely fashion. These problems can spiral out of control if not managed properly.

You can improve your cash flow by using accounts receivable financing. This solution allows you to sell accounts receivable, which gives your business immediate funds. You can use these funds to pay suppliers or employees or to make new investments.

Transactions are usually structured to finance your accounts receivable in two installments. The first installment covers up to 85% of the value of your receivable and is funded when invoices are submitted. The remaining 15%, less financing fees, is usually paid once your customers pay their invoices in full.

The cost of financing receivables varies based on the creditworthiness of your invoices, your volume, and your industry. In general, costs range from 1.15% to 3.5% per 30 days. To learn more about this solution, read “How does accounts receivable financing work?

Option #2: Inventory financing

Another source of cash flow problems is having too much money tied to inventory. This problem happens if inventory turns slower than expected or if you have excess inventory. You can improve your cash flow by financing your inventory.

However, inventory financing has a few challenges. Setting up and maintaining the line can be expensive due to the review requirements. As part of its initial due diligence, the finance company has to send a specialist to your facility to verify the count and status of your inventory. This type of review has to be done regularly so that the funding company can verify the collateral.

Aside from having high setup costs, most finance companies finance inventory based on its forced liquidation value. The forced liquidation value is usually much lower than regular market value. This valuation affects the amount of financing that your company can get. Furthermore, due to the nature of inventory, most companies can finance only 50% of the liquidation value. Consequently, clients consider this type of financing to be labor-intensive and expensive.

Combining A/R and inventory financing

Receivables financing and inventory financing are usually offered as stand-alone products by finance companies. However, clients that have both types of assets can use either or both types of financing. Most receivables financing companies have inter-creditor agreements that enable them to work with invoice financing companies.

In some cases, the factoring company is asked to pay the inventory financing from invoice financing proceeds. As such, once inventory is sold off and invoiced to a client, the factoring company uses part of the factored invoice’s proceeds to pay off the inventory line component.

Option #3: Supplier Financing

Supplier financing is offered to companies that need funds to pay suppliers and build inventory. It works by partnering with a finance company that provides your company with trade credit, enabling you to buy additional products from your suppliers.

This solution is available to manufacturing companies and product distributors that have minimum yearly revenues of $2,000,000 (higher is preferred). Additional qualification criteria can be found here. To learn more about supplier financing, read “What is supplier financing?

Option #4: Asset-based lending

Midsize companies have an additional alternative – asset-based lending. Asset-based financing provides an all-encompassing solution that allows you to finance receivables, inventory, and machinery. It’s used by companies that exceed the requirements of normal receivables and inventory financing lines but can’t qualify for bank financing yet. Generally, a company must have monthly revenues of $1,000,000 or more to qualify.

Asset-based lending (ABL) facilities have a number of benefits over other types facilities. The cost of financing is usually cheaper than receivables factoring and inventory lending. The lines have fewer direct lender controls because they are offered to larger companies with good internal controls. To learn more about ABLs, read “Asset-based financing basics.

Which solution works best?

Accounts receivable financing and inventory financing lines are usually offered to small and growing companies. Generally, it’s best to start with an accounts receivable financing line because it’s cheaper and easier to use. If this line does not meet all your working capital needs, then consider adding an inventory financing or supplier financing as needed.

Larger companies are usually better off with an asset-based lending line. These lines provide all the benefits of receivable and inventory financing as a single facility but for a cheaper price.

Do you need financing?

We are a leading factoring and asset-based lending company and can provide you with a competitive financing proposal. For a quote, fill out this form or call (877) 300 3258.