How Does Accounts Receivable Financing Work?

Companies often work with commercial clients who pay their invoices in 30 to 60 days. Giving clients net-30 terms is common for many companies. Unfortunately, some companies don’t have the cash reserves to wait that long for payment. They need to get paid sooner so that they can pay for their own expenses.

Accounts receivable financing helps companies by allowing them to finance their slow-paying invoices. This article shows you how the receivables financing process works so you can decide if it is a good fit for your business.

Step 1: Due diligence and account setup

The first step of the receivables financing process is performing the due diligence so the account can be set up. The due diligence allows the finance company to determine if your company can be financed. The finance company usually checks:

  1. The credit quality of your clients
  2. Your receivables aging report
  3. If any liens encumber your receivables
  4. If your corporate taxes are up to date
  5. The relevant background of the business owners

If you request a large funding facility, the finance company also reviews your company’s financial statements. Once the due diligence is completed, contracts are signed, customers are notified, and the account is put in place.

Step #2: Getting your receivables ready

Once the account is ready, the next step is to select the clients and receivables that will be funded. Once customers have been selected, their invoices can be submitted to the receivables financing company through a secure website, by email, or by fax. Invoices are usually submitted along with a schedule of accounts document. The schedule of accounts serves as the formal request for funding.

Step #3: Accounts receivable verification

Once the receivables are received, the financing company verifies them with the customer. The objective of the verification is to ensure that the invoice amounts are right, that there are no offsets, and that they are due in 30 to 60 days. This step helps prevents problems in the funding process.

Step #4: Financing the batch of receivables

After verification, the invoices are ready for funding. The finance company calculates the advance and deposits the funds in the client’s bank account.

The advance is the percentage of the invoice that is funded. It varies by industry and other criteria but averages 80%. In general, advances are provided within a business day of getting the funds request.

Funds can be sent to the client by wire transfer or by direct deposit (ACH). Wire transfers provide funds availability the next business day. Direct deposits can take a day or two, depending on your bank.

Step #5: Payments and settlement

Your customers pay invoices on their regular schedule. Mailed payments are sent to a lockbox. The lockbox is a facility that allows the factoring company to process check payments in your name. If your customer pays electronically, the funds are deposited to a special account.

Once the funds are received, the transactions are settled. Invoices are marked as paid and the remaining 20% that was not initially advanced, less a financing fee, is rebated.

Step #6: Ongoing process

Most companies finance their receivables as part of an ongoing process to improve cash flow. It is as simple as repeating steps two through four. Factoring accounts receivable provides companies with funds to pay for expenses and to run the business.

Contract termination

One common question from clients is how to handle contract terminations. Basically, what happens when you no longer need to finance your accounts receivable?

There are a few ways to terminate contracts, and you should speak to your finance company directly because the process varies. In general:

  1. If you are moving to a new lender (e.g, a bank), you use the proceeds of the new lender to close your factoring account.
  2. If you are no longer using financing, you let accounts pay out. The factor closes invoices as they pay and closes your account when the last invoice pays.

Similar products

Usually, entrepreneurs use the terms “factoring,” “invoice factoring,” and “accounts receivable financing” interchangeably. One product that provides the same benefits as factoring but operates differently is asset based lending. Asset based loans allow you to finance invoices and other products, but they operate much like revolving lines of credit. These loans are available to larger companies that have a minimum of $1,000,000 in monthly revenues.

Need financing?

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