Accounts receivables finance comes in the form of a cash advance or a line of credit secured against the amount a business has accrued in outstanding invoices. It’s a type of financing designed to help to solve cash flow issues which are created by customer payment terms on invoices. After a business has provided goods or services, they have to wait to be paid and the length of time they have to wait – particularly for larger sum invoices – can vary between debtors.
Receivables finance goes by many names and often comes bundled with a lot of confusing jargon. It can be known as invoice financing, debtor finance, cash flow finance or, as here, accounts receivables finance. Once you start exploring various types of business finance, you come across even more confusing jargon such as invoice discounting and invoice factoring. These are slightly more specific terms and describe types of receivable finance options. The more you explore, the more detailed each term becomes. There is full-ledger, partial ledger, selective invoice discounting and disclosed or non-disclosed. There is also recourse or non-resource facilities available. But what do they all mean and how could your business benefit from any of them?
Understanding accounts receivables
A company’s accounts receivable (or AR) is money they are owed by their customers for goods or services they have delivered. Once an invoice is sent and until it is settled, those funds become part of their accounts receivable. The term is used to define both the funds owed and the process of collecting it, which includes sending invoices, chasing the money and reconciling payments against invoices.
Goods and services are generally supplied on credit terms, which is an agreed period of time before the payment must be settled. Once the due date has passed, if an invoice has not been paid it is known as aged (by the number of days since it was due).
The opposite of accounts receivable is accounts payable - funds owed to a third party who has delivered a good or a service along with an invoice.
Accounts receivable is considered an asset. It will be listed on a company’s balance sheet as a current asset and it can be used as collateral for a loan or sold to a third party who will take over collections.
What is accounts receivable financing?
Let’s try and unpick some of the mysteries of the strange world of receivables finance!
To start off with, accounts receivable financing is almost as old as money itself. The sale of receivables has a long history and it is one of the oldest forms of commercial finance. The ancient Babylonians were the first to discover the power of the invoice around 4,000 years ago and quickly discovered the convenience of trading receivables soon after. The world may have moved on a little since then, but the basic idea still remains the same.
A business supplying a good or service will raise an invoice to the company they are trading with. That company then becomes a debtor. The debtor is required to pay the invoice amount in line with the specified payment terms which is often between 30 and 60 days. The time a business must wait for their invoice to be paid creates a cash flow finance problem for that first business. They have carried out their work and paid for whatever time and materials they needed to supply those goods or services, but they have to wait to be paid. This can restrict their ability to carry out their operations, meet their overhead costs and the demands of their payroll.
Receivables finance is used by businesses to help them grow and expand.
Accounts receivable finance is there to smooth out day to day cash flow bumps. It helps businesses to purchase inventory, equipment and raw materials. It pays for operational expenses and helps them cover payroll.
The receivables finance company is interested in the creditworthiness of the debtors, as well as the quality and the age of the invoices. Newer invoices are considered more valuable because there is less risk assumed by the accounts receivable financer. Newer invoices have no history of not being paid so it’s assumed that they will be settled within the agreed upon payment terms. Other factors financing companies will consider include concentration (the number of debtors) and ageing (how overdue the invoices are). It’s generally considered better to have multiple invoices due from multiple vendors rather than a high concentration of invoices due from a single debtor.
Accounts receivable finance in Australia
This is big business in Australia. The total industry volume for 2017 was over $75bn!. Despite this enormous sounding number, the adoption of receivables finance is still much lower than in other countries. $75b only amounts to just 3% of GDP in Australia, compared to almost 15% of GDP in the United Kingdom.
It’s possible that this low percentage is due to Australian businesses having more secure cash flow. However, whilst payment terms here are lower than the regional average (25 days), 84% of Australian businesses report late payments from their B2B customers. So why aren’t more businesses accessing this kind of finance option to help maintain healthy cash flow? That is a very good question.
There are two main types of accounts receivable finance:
This is where a business sells invoices to a third-party lender (factoring companies) who will then collect that invoice payment directly from the customer. The business receives an advance, usually 70-85% of the total value, and once the debt is paid, the factor (the receivables financing company) remits the final amount, minus the factoring company’s fee. Credit control and collections become the responsibility of the factoring company. They credit check customers, chase payments and deal with them on behalf of the business.
This type of finance is most often used by small businesses, including start-ups, who need quick access to working capital to grow. These businesses will often find that other funding options in the Australian finance market are unable to them.
The pros & cons of invoice factoring
|It provides a quick cash flow boost - giving business owners the opportunity to pay staff, cover operational costs and grow||Expensive compared to other types of business loan|
|The amount available grows as more invoices are raised||The amount available is limited by the value of the invoices|
|Not asset-based - no fixed assets as collateral||Long term contracts (often 24 months)|
|The factor takes over the admin of credit control and collections||Can damage customer relationships|
|A non-recourse facility can offer protection against bad debts||It exposes your situation to your customers|
|Relatively easy to obtain funding||It comes with a somewhat negative reputation|
This form of finance is similar to invoice factoring and the sale of receivables, with one main difference; the financing company stays in the background which means that collections for outstanding invoices remain the responsibility of the business. It is suited to slightly more established businesses than invoice factoring is. The business retains control of its credit and collections, meaning it remains in control of its customer relationships too.
The pros & cons of invoice discounting
|It provides a quick cash flow boost - giving business owners the opportunity to pay staff, cover operational costs and grow||Fixed costs. Often comes with a fee for all invoices|
|The amount available grows as more invoices are raised||Unlike factoring, no help with finance work / credit control|
|No fixed assets as collateral||The amount available is limited by the value of the invoices|
|Important customer relationships stay within the business||Available to established businesses|
|Short term option without long contracts||Although some lenders insist on a minimum contract period with minimum fees|