Accounts receivable financing allows companies to receive early payment of their outstanding invoices. A company using accounts receivable financing commits part or all of its outstanding invoices to a financier for prepayment in exchange for a fee.
What are the three main types of accounts receivable financing?
- Asset-based lending (ABL): also known as a trade line of credit or traditional commercial loan, asset-based lending is an on-balance sheet technique and generally carries significant fees. Companies commit most of their receivables to the program and have limited flexibility over which receivables are committed.
- Traditional factoring: In factoring, unlike reverse factoring, a company sells its receivables to a financier, but the down payment is for less than the full amount of the receivable. For example, a company may receive a prepayment of 80 percent of the invoice amount minus processing fees. Compared to asset-based lending, companies have more flexibility in choosing which receivables to market, but funder fees can be high and lines of credit can be smaller. As with ABL, any factored receivables are recorded on the company’s balance sheet as outstanding debt.
- Selective accounts receivable financing: Selective accounts receivable financing allows companies to choose which receivables to advance for prepayment. In addition, selective accounts receivable financing allows companies to guarantee prepayment of the full amount of each receivable. Financing rates are typically lower than other alternatives, and this method may not count as debt under the structure of the program. Because selective accounts receivable financing remains off-balance sheet, it does not affect debt ratios or other outstanding lines of credit.
Why is selective accounts receivable financing often a preferred option?
Compared to asset-based lending and traditional factoring, selective accounts receivable financing generates cash flow gains more efficiently and often at lower costs and risks. Here’s why:
- Not counted as debt: When structured correctly, selective accounts receivable financing remains off a company’s balance sheet and therefore has no impact on outstanding borrowings or future requirements for lines of credit and similar financing.
- Companies choose which receivables are prepaid: Companies can choose which receivables they wish to send for prepayment rather than offering their entire accounts receivable book on a rolling basis. As a result, they can more closely control their ability to offset cash flow gains and financing costs.
- Flexibility to choose when to participate: Selective receivables financing allows companies to participate only when they need to. This is key for companies that experience seasonal demand or during periods of economic volatility.
- Ability to leverage multiple funding sources: Unlike other options, selective receivables financing allows companies to incorporate multiple funders into one program. This reduces the risks inherent in relying on a single financial institution (even when a bank will restrict liquidity due to changes in its own circumstances).
- More favorable pricing: By incorporating multiple funding sources, selective receivables financing improves price competition.
How do selective receivables financing work?
The most successful selective receivables financing programs are powered by state-of-the-art software platforms that allow companies to sell their invoices for prepayment well in advance of the actual due date and, in most cases, without any involvement or disclosure to their customers. . By facilitating a true sale of receivables, without factoring or a loan, the platform automatically handles all transactions between multiple customers and provides companies with additional cash flow in different countries and currencies.