Having cash flow problems is a common challenge for companies of all sizes. Fortunately, many cash flow problems can be solved by improving operations, using financing, or combining both options.
This article focuses on how to get financing by using your Accounts Receivable (A/R) as collateral. We cover three financial options that use your A/R: commercial lines of credit, receivables lines of credit, and receivables factoring. You will learn how:
- Lenders view your A/R as collateral
- Conventional lines of credit work
- An A/R line of credit works
- Receivables factoring works
- To choose which option is best for you
Lenders and accounts receivable
Lenders consider your A/R – invoices that will be paid in 30 to 60 days – as solid collateral. It’s an asset that can be turned into cash relatively quickly. For this reason, most financing solutions are secured by the client’s accounts receivable.
To use your receivables as collateral, they must be high quality. Your customers must have good commercial credit. Also, the invoices must be accurate, and your company must follow good collection practices.
There are two ways can secure financing against your Accounts Receivable. One option is to margin your A/R, in which a lender provides a line of credit secured by the asset. This is the preferred option for many larger companies.
The second option is to sell your receivables to the finance company. This option allows you to sell the financial rights to your invoices in exchange for immediate funds. This method is less restrictive and works better for smaller companies.
Option #1: Business line of credit
The most well-known, flexible, and cost-effective solution to finance your accounts receivable is a business line of credit. Lines of credit provide funding up to a preset amount. Your company can draw funds as needed, up to this limit. You can pay down the line as your cash flow improves.
Although some lines of credit can be secured solely by Accounts Receivable, most require additional collateral. The value of A/R changes regularly, and lenders often worry it could drop below the loan limit. This situation would leave them under-collateralized. Consequently, companies are usually required to post additional collateral to prevent this scenario. Assets include inventory, machinery, bank accounts, and other property.
Lines of credit are the best solution for well-established companies with a long track record and audited financials. Unfortunately, they don’t work with small companies that can’t meet the qualification or collateral criteria.
Option #2: Accounts receivable line of credit
An accounts receivable line of credit, commonly called sales ledger financing, is a good option for companies that can’t qualify for a business line of credit. This solution provides many of the benefits of a line of credit but has easier qualification requirements.
The financing line is linked to the value of your eligible accounts receivable. You can draw up to 80% of your eligible receivables at any given time. The line is paid off when customers pay their invoices on their usual schedule. Sales ledger financing lines are dynamic and change as your sales fluctuate.
Sales ledger financing works well for small and midsize companies that are relatively well-established. Companies must have a decent track record and invoice at least $350,000/month to qualify for this solution.
Option #3: Accounts receivable factoring
Factoring your invoices is a tool that allows you to get financing that is secured by accounts receivable. However, there is an important difference from other solutions. Although the line behaves much like a line of credit, it’s technically a receivables sale. This difference is important because it makes the line more attainable to small companies.
Your company gets financing by selling its accounts receivable to a factoring company in exchange for immediate payment. The sale occurs in two installment payments.
The first payment covers 80% of the value of the A/R. It is deposited into your bank account when you present the invoices for financing. The remaining 20%, less the finance fee, is deposited once your customers pay their invoices in full. For more details, read “How does invoice factoring work?”
Companies that use factoring often finance their invoices regularly (usually weekly). This approach provides them with dependable cash flow that can be used to fund operations and growth. Since the line is tied to your accounts receivable, it can grow as your sales increase.
One advantage of factoring is that your company size does not matter. This solution is available to companies of any size, as long as they have invoices from reputable commercial clients. Get more information about A/R factoring.
Which option is best for my company?
Using the right financing is critical to the success of the company. Business owners must review these options with their finance teams. The product best suited for your company depends on:
- The size of your revenues
- How long you have been in business
- The quality of your financial statements
- Whether your company is growing quickly or has matured
If your company is large, established, has a track record, and is doing well, a business line of credit is usually the best option. They provide the most flexibility at the lowest possible price.
Companies that generate at least $350,000 and are in reasonably good shape should consider sales ledger financing. This solution provides flexibility that is comparable to a line of credit. The cost is higher than a line of credit, but the qualification requirements are simpler.
Lastly, companies that cannot qualify for sales ledger financing should consider accounts receivable factoring. This solution is more expensive than other options. However, it provides many of the benefits of the previous solutions but is much easier to obtain. Small companies that have a good client roster can usually qualify for factoring.
Do you need financing?
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Note: This article is for information purposes only and does not intend to provide financial advice. If you need financial advice, please consult a specialist.