What it is — plain definition
– Accounts receivable (AR) financing is a way for a business to get cash now based on money it is owed by customers for invoices that haven’t been paid yet. These unpaid invoices (accounts receivable) appear as current assets on the balance sheet because customers are expected to pay within a short period, typically under a year.
Why businesses use it
– AR financing converts expected cash flows into immediate working capital so companies do not have to wait for customers to pay. That can ease payroll, inventory, or growth funding needs without taking on a typical bank loan.
Quick-ratio reminder (liquidity context)
– Quick ratio = (Cash equivalents + Marketable securities + Accounts receivable due within one year) / Current liabilities
– Because receivables are among a company’s most liquid assets, lenders and financiers often treat them as valuable collateral.
Two common deal structures
1) Asset sale (factoring)
– What happens: The business sells some or all of its invoices to a financier (a factor). The factor pays a portion of each invoice up front and takes responsibility for collecting payment from the customer.
– Who bears default risk: Often the factor assumes the collection/default risk once the invoices are bought (terms vary).
– How the factor makes money: By buying receivables at a discount (paying less than full invoice face value) and charging fees.
– Typical mechanics: A factor may advance up to about 90% of an invoice’s face value up front, then remit the remainder after collection, less fees. Many factoring providers connect to accounting software (e.g., QuickBooks, Xero, FreshBooks) to automate invoice submission.
2) Loan (receivables used as collateral / advance)
– What happens: The business retains ownership of its invoices but receives a cash advance or line of credit secured by those receivables.
– Who bears default risk: The borrowing business usually keeps the collection and default risk; it must repay the advance with interest and fees.
– Typical mechanics: Some lenders can advance the full invoice amount (100%) up front; repayment schedules and cost depend on the lender’s terms. Integration with bookkeeping systems may allow advances against individual invoices or dynamic management of credit limits.
Underwriting factors financiers consider
– Who owes the invoice: Receivables from large, creditworthy customers generally command better terms than invoices from small or uncertain payers.
– Age of receivables: Newer invoices are preferred; older or delinquent receivables reduce the amount a financier will advance.
– Systems and integration: Ability to link accounting software to the financier’s platform can speed approval and allow invoice-by-invoice advances.
– Structure chosen: Whether the deal is an asset sale or a loan changes who bears collection risk and affects pricing.
Advantages and disadvantages (summary)
Advantages
– Turns invoices into immediate cash.
– Often faster to obtain than some other financing types.
– Technology integrations can make the process efficient and scalable.
Disadvantages
– Fees and discounts reduce the net proceeds received.
– Under loan structures, the business must repay the advance with interest.
– Under sale structures, the business may lose control over collections and cede some margin to the factor.
Checklist before you apply
– List the top customers and verify their credit quality.
– Calculate average invoice age and proportion of receivables under 30/60/90 days.
– Confirm whether you need recurring working capital or one-time cash for specific invoices.
– Check which accounting systems you use (QuickBooks, Xero, FreshBooks) and whether a financier integrates.
– Decide whether you prefer to sell invoices (remove collection risk) or borrow against them (retain ownership).
– Request sample term sheets showing advance rates, fees, and final remittance mechanics.
Worked numeric examples (simple, illustrative)
1) Asset-sale (factoring) example — assumptions noted
– Assumptions: single invoice for $10,000; factor advances 90% up front; fee on final settlement = 4% of invoice (assumption for illustration).
– Up-front cash = 90% × $10,000 = $9,000.
– When the customer pays $10,000, factor holds back the remaining 10% = $1,000 and subtracts the fee: fee = 4% × $10,000 = $400.
– Final remittance to seller = $1,000 − $400 = $600.
– Total cash to seller = $9,000 + $600 = $9,600 (effective cost = $400 fee).
2) Loan (advance) example — assumptions noted
– Assumptions: same $10,000 invoice; lender advances 100%; borrower repays principal plus a flat 3% fee (assumption).
– Up-front cash = $10,000.
– Repayment when due = $10,000 + (3% × $10,000) = $10,300.
– Cost to borrower = $300.
Notes about these examples
– Fee levels and advance percentages vary widely by provider, customer-credit quality, invoice age, and deal structure. The numeric examples use round assumptions for clarity; verify actual rates with prospective financiers.
Practical steps to proceed
1) Assemble recent aged receivables report and customer list.
2) Decide whether you want to sell invoices or borrow against them.
3) Contact providers that integrate with your accounting software.
4) Request detailed term sheets and run a cost comparison (advance rate vs. fees vs. repayment schedule).
5) Run a small pilot with a single invoice or short period to validate operational impacts.
Selected reputable sources for further reading
– Investopedia — Accounts Receivable Financing: https://www.investopedia.com/terms/a/accountsreceivablefinancing.asp
– BlueVine (factoring and AR financing provider): https://www.bluevine.com
– Fundbox (receivables-based advances and lines of credit): https://fundbox.com
– QuickBooks (accounting software and integrations): https://quickbooks.intuit.com
Educational disclaimer
This explainer is for educational purposes and does not constitute individualized financial, legal, or tax advice. Terms and fees for AR financing vary by provider and borrower; consult a qualified advisor and review specific contract terms before entering any financing arrangement.