How to Use Accounts Receivable Financing in a Growing Business

It can be a fast, flexible way to access working capital. 

Fast-growing companies, especially newer ones, often struggle to pay for that growth. 

It takes money to invest in larger orders, bigger teams and greater production capacity, and those companies can’t always access the necessary capital. 

Even if their sales are strong, fast-growing companies sometimes wait months for customers to pay. Banks often refuse their requests because the companies don’t have enough credit history or fail to meet other lending standards. 

This is why many up-and-coming businesses use accounts receivable financing (AR financing) to increase their working capital quickly. They can use their outstanding invoices as a source of funding.

Plus, this lets companies avoid the risk of long payment terms when operating internationally. A sudden shift in foreign exchange or interest rates could reduce the effective value of an invoice.

What is accounts receivable financing? 

AR financing is a type of funding where a company’s outstanding invoices are sold or used as collateral for a loan. Many financiers will accept receivables because they hold value and they’re relatively liquid.

Compared with a traditional bank loan, using AR financing is fast. That’s important for growing companies whose opportunities and needs pop up unexpectedly. 

Like any other asset, the receivables are usually subject to underwriting rules. Are the customers involved good credit risks, too? Are there any liens against the receivables? 

How can fast-growing companies use AR financing?

With AR financing, companies can:

• Negotiate better pricing or discounts because they can place bigger orders or pay upfront
  
• Use strategic cash management to adapt seasonal needs or meet debt payments
  
• Add equipment or resources to expand capacity
  
• Invest in more sales and marketing to increase revenue
  
• Quickly cover unexpected expenses, such as essential repairs to equipment and property
  
• Hit their goals for key metrics such as days sales outstanding (DSO) and cash conversion cycle (CCC)

Types of accounts receivable financing

Factoring

With this option, a company sells its receivables to another business known as a factor. The factor advances 70% to 90% of the receivables’ value back to the company. The company enjoys an almost-immediate increase in its working capital. 

The factor collects the full amount of the receivables from the company’s customers by the original due date. Then the factor sends the remaining 10% to 30% of the invoices’ value to the company, after the factor subtracts its fees. 

The fees usually equate to 1% to 5% of an invoice’s value. If your company uses factoring, make sure you have a clear understanding of how fees are structured. Some factors will charge separate fees for ACH payments, invoice uploads and other steps.

Under some factoring arrangements, the factor takes responsibility for handling slow-paying and nonpaying customers. Its approach to collections might be more aggressive than how your company would normally manage the situation. In a worst-case scenario, it could damage the client relationship. 

Loans and lines of credit

Some lenders will offer loans and lines of credit to companies based on the strength of their receivables. In some cases, the lending will be secured by the receivables as collateral. So, if the company defaults, the lender takes possession of the receivables. 

Like any loan, it’s a form of debt. The company pays interest and fees. 

Invoice discounting 

Companies can also unlock value from their receivables by offering a discount to customers that pay before the due date. 

For decades, companies used static discounting to encourage early payment. A lot of them still do. One of the most popular discount offers is 2/10 net 30. That is, a customer can earn a 2% discount if it pays its invoice within 10 days. Otherwise, the full amount is due in 30 days. 

More businesses are offering dynamic discounting today. The size of a customer’s discount dynamically changes depending on when they pay. Generally speaking, the earlier someone pays, the larger the discount. 

Early Pay Programme

C2FO’s platform offers dynamic discounting that gives suppliers more control. With the platform’s Name Your Rate^Ⓡ feature, they can set the size of the discount. Generally, they also control when to offer a discount and which invoices they’ll offer discounts on. (Some factors will do one-off or spot financing, but most want long-term contracts of several months.) 

Unlike factoring, your company retains control of its invoices and the client relationships. Invoice discounting doesn’t require your company to take on debt like a loan would. You’re not borrowing. You’re just receiving money that your customer was already supposed to pay. 

The bottom line 

Intense growth can put intense pressure on companies. Dynamic discounting gives companies access to the capital necessary to seize all the advantages coming their way — without a lot of the barriers that come with other solutions, without running the risk of their invoices losing value due to changes in interest rates, foreign exchange and other forces. 

If your company is interested in using dynamic discounting, C2FO has created a suite of solutions that are designed for all kinds of businesses. Learn more here.