Selling Accounts Receivable to Obtain Short-Term Funds

Summary: Companies experience short-term cash flow problems every so often. It is a common business problem that can happen due to sudden growth, large clients paying slowly, or other reasons.

The typical approach to solving this problem is to get a loan. However, loans and lines of credit aren’t always the best solution. Qualifying for a line of credit or a loan can take weeks or months. If you get the loan, you will usually need to commit for some time.

Companies can often solve their short-term cash flow problems by selling their accounts receivable. Receivable financing lines are easier to obtain than bank financing and can be used to handle short-term problems. In this article, we discuss:

  1. Why would a company sell its accounts receivable?
  2. Can invoices be sold?
  3. How are accounts receivable sold?
  4. Is A/R financing the right option for your company?

1. Why would a company sell its accounts receivable?

Companies sell their receivables because it can be a quick way to improve their cash flow and handle short-term financial needs. Cash flow problems are often related to offering net-30- to net-60-day terms to clients. Offering payment terms can create financial problems for companies that don’t have a sufficient cash reserve.

Some companies can improve their cash flow without financing by offering early payment discounts. This strategy provides customers with a 2% discount if they pay their invoice within ten days. Otherwise, they pay the total amount.

Early payment discounts can help with short-term problems but aren’t always reliable. They are optional. Your clients can take them or not, based on their own circumstances. A better alternative is to finance your company by selling its A/R.

2. Can accounts receivable be sold?

An invoice is considered an intangible asset to the issuer. The financial rights associated with that invoice can be sold, assigned, or transferred, just like any asset. The process is similar to a conventional asset sale, with some modifications to account for the flow of funds.

There are some general criteria that must be met so that your company can sell invoices to a finance company. Here are the most important ones.

a) Work must be completed, or product must be delivered

The work associated for an invoice must be completed. If the invoice is for a product sale, the product must be delivered and accepted by the client. Invoices for pre-billed work cannot be financed.

b) Invoices must be from commercial clients

Your invoices must be from commercial or government clients. These invoices are usually on net-30- to net-90-day terms. Additionally, invoices must be from clients with good commercial credit. The finance company relies on your client’s ability to pay the invoice.

c) A/R must be free of liens

Your accounts receivable cannot be encumbered by a lien. These liens are common when companies take a loan or similar financing. Finance companies will not buy invoices that are encumbered by liens from other finance companies.

d) Company must not have serious tax problems

A company may be able to sell its invoices if they have some tax problems as long as there is a payment plan in place. However, taxing authorities will need to subordinate their positions to any liens they have filed.

e) Payments flow to the finance company

Your client’s payments will flow to the finance company. The finance company effectively purchased this payment when you sold the invoices. Note that selling invoices is fairly common. Most midsize and large companies are familiar with the payment procedures.

3. How are accounts receivable sold?

The easiest way to sell your invoices is to use accounts receivable factoring. This solution is offered by specialized finance companies. It has gained popularity in recent years as an effective way to handle short-term cash flow problems.

a) How does accounts receivable factoring work?

Factoring allows you to finance your invoices by selling them to a factoring company. Most factoring companies buy invoices in two installments. The initial installment, called the advance, covers around 85% of the invoice. The advance is deposited in your bank account when you sell the invoice.

The remaining 15%, less the fee, is deposited to your company’s account once your end customer pays the invoice in full. This installment settles the transaction. To learn more about how the solution works, read “What is Accounts Receivable Factoring and How Does it Work?

b) How much does it cost?

The cost of factoring depends on the size of your invoices, the credit quality of your clients, and your industry. Larger transactions with high-quality invoices are less risky and get lower rates. In most cases, the factoring rate ranges from 1.15% to 3.5% per 30 days. The fee can be prorated to account for shorter or longer periods.

c) How quickly can you set up an account?

One of the main advantages of accounts receivable factoring is that your account can be set up quickly. In most cases, an account can be set up in a couple of days. Note that setting up an account for larger transactions or companies with problems may take longer due to their complexity.

d) Is factoring available for short-term needs?

Factoring lines may be used for a short period of time. This time frame is negotiable and varies by factoring company. Some finance companies offer no-minimum plans that clients can use as needed. Other factors may require that you factor for a set period of time, such as three months or a year.

Note: Using factoring for less than three months is not recommended.

4. Is A/R financing the right option for your company?

Factoring is specifically designed to help companies that cannot afford to wait 30 to 60 days to get paid by clients. It works very well to improve cash flow and provides a solid platform for growth.

To benefit from this solution, companies should have:

  • Cash flow problems due to slow-paying clients
  • Clients with good commercial credit
  • Profit margins exceeding 15%
  • Unencumbered invoices

Do you need accounts receivable factoring?

We are a leading factoring company and offer short-term receivables financing at competitive terms. For a quote, fill out this form or call us toll-free at (877) 300 3258.