Since the financial crisis of 2007 – 2008 over a decade ago, lenders have tightened their requirements for businesses that they choose to extend loans to. This leaves many businesses in the lurch with fewer options for financing, particularly those that may have problems with outstanding invoices. To fill this gap and offer additional funding options, some lenders have been extending “accounts receivable loans” (AR loans) that feature less restrictive guidelines and additional customer benefits. Considering that your business needs readily- available capital to grow, AR loans offer a way to free up cashflow problems that arise from outstanding invoices and customer debts, which are sold to lenders at a discount.
In this article, we’ll take a look at what you need to know about accounts receivable loans.
How Do Accounts Receivable Loans Work?
Accounts-receivable loans are a type of asset-financing arrangement between a business and lender that uses the company’s outstanding receivables (debts owed to a company by its customers for goods or services that have been used/delivered but not yet paid for) to receive financing. In exchange, the business receives an amount that is equal to a reduced value of the receivables pledged in the loan agreement. Essentially, AR loans help free up capital that’s stuck in unpaid debt, transferring the “default risk” to the financing company. This process is also known as “factoring”.
How Factoring Companies Price Accounts Receivables
Default risk is a factor in how much financing the business receives, as older debts/receivables are considered more risky and are less likely to be paid off by debtors. Newer debts are considered more valuable than older invoices for this reason, as financing companies want to recoup the maximum amount for assisting the business. Similarly, debts owed by larger corporations and companies are also considered more valuable than invoices owed by individuals or small companies, as larger entities have access to more resources and are deemed more reliable.
Once the factoring company collects the debts, it pays the original company any remaining amount beyond the financing amount minus a factoring fee. Financing companies that offer AR loans typically advance businesses 70 to 90% of the value of their outstanding invoices.
Benefits of AR Loans over Bank Loans
As you can imagine, AR loans come with a vast array of benefits:
First, the approval process for AR loans is quick, often only taking a few days before companies receive money for their outstanding debts.
Second, when a business leverages its accounts receivables to boost its cash flow, it does not have to worry about repayment schedules and tracking down individual clients to get money paid up. Instead of wasting time and resources focusing on trying to collect outstanding bills, the company can focus on other core aspects of its business.
Third, there’s no need for businesses to have collateral in the decision-making process for AR loans. Instead, the accounts receivable themselves are the collateral that lenders use to lend money to businesses.
Fourth, a business’ established credit history is irrelevant for determining whether a lender provides funding to a business. Instead, the credit history of customers that owe money to the business are factored in the lender’s decision to approve an AR loan.
Last, an AR loan is a bit of a misnomer, as these are not loans. Therefore, no additional debt is incurred by the business—something that other forms of quick-approval loans (i.e. merchant cash advances) can come with, compounding the financial situation of a perhaps already-struggling business. Therefore, AR loans are low-risk and high-reward for businesses.
Disadvantages of AR Loans
Of course, there are a few negative perceptions associatied with AR loans and factoring. Financing through factoring typically costs more than financing through traditional lending methods. Because of the “fast cash” associated with AR loans, this method may also give the perception that a business is incompetent and lacks leverage to collect on what’s legally owed to the company. However, in truth, many upwardly-mobile companies use AR loans to establish a profit versus the costly and time-consuming process of invoicing, tracking down who is responsible for paying, and so forth.
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Now that you have an understanding of AR loans and factoring, you may be interested in seeing if they’re a good fit for your company. Whether your company specializes in construction, manufacturing, and other industries, or that you’re waiting for medical receivables from insurance company, Evolution Capital Group can help. In many case, Evolution Capital Group can quickly approve your AR loan application within a 3-day turnaround time so that your business can focus on what it does best. Visit evocapitalgroup.com for more details.