Accounts Receivable Financing Definition
Accounts receivable financing is a method of financing in which a company obtain funding for its operations through money owed by its customers. When a business sells its accounts receivable with the aim of converting them to cash for business operations, it is an account receivable financing.
A company that uses this type of financing would derive funds from receivables pledged by customers who owe the company. This would help the company reduce the rate of unpaid debts (accounts receivable) and at the same time gather funds for operation.
A Little More on What is Accounts Receivable Financing
When a company converts outstanding invoices and debts owed by customers to cash for financing the company, this is an account receivable financing method.
Outstanding invoices are sold in order to receive amount of money pledged by customers who owe the company. The factoring company that collects or purchases the debt pays the company an amount of money but the factoring fee is deducted.
Companies are able to free capital stuck as unpaid debts by using accounts receivable financing method. Up to 90% of the value of outstanding invoices can be redeemed using the accounts receivable financing method.
How Factoring Companies Price Accounts Receivables
Companies that want to convert their accounts receivable into cash quickly without having to wait till the time the credit terms expire use factoring companies. They sell the accounts receivable to factoring companies in exchange for immediate cash.
However, the amount offered by factoring companies for accounts receivable is dependent on certain factors. For instance, the size of the company offering the accounts receivable is one of the factors factoring companies consider. While invoices owed by large companies attract higher amount of money, invoices owed by small companies pay lower.
Furthermore, factoring companies pay more for new invoices than old invoices. Generally, a company is required to pay a factoring fee of between 1% and 5% for accounts receivable financing.
Helping Companies With Accounts-Receivable Financing
Often times, waiting for the duration of the credit terms require much time and because companies are likely to be in need of money for immediate operating purposes, they opt for accounts receivable financing. This is a type of financing that grants a company access to immediate funding without having to wait for a long duration. In most cases, companies sell outstanding invoices to factoring companies who pay them in exchange for the invoices.
Also, hurdles associated with securing business loans are avoided when companies use the account receivable financing. This is a unique, reliable and fast financing option for businesses.
Negative Perceptions Associated With Factoring
Despite the many benefits that companies derive from accounts receivable financing using factoring, there are some disadvantages that have been outlined.
Factoring gives companies quick and easy access to funds in exchange for invoices but in most cases, it is more expensive than the traditional financing method (using traditional lenders).
Also, there is a bad perception of companies that use factoring companies, they are regarded as either poor or failing companies. As against this perception, analysts maintain that this belief cannot be proven and in the real sense, successful companies also turn to factoring or accounts receivable financing when the need arises.
Reference for “Accounts Receivable Financing”
Academic research on “Accounts Receivable Financing”
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Value Judgments: Accounts Receivable Financing and Voidable Preferences Under the New Bankruptcy Code, Cohen, N. B. (1981). Value Judgments: Accounts Receivable Financing and Voidable Preferences Under the New Bankruptcy Code. Minn. L. Rev., 66, 639.
Accounts Receivable Financing: Transition from Variety to Uniform Commercial Code, Craig, C. C. (1962). Accounts Receivable Financing: Transition from Variety to Uniform Commercial Code. BUL Rev., 42, 187.
Inventory and Accounts Receivable Financing: The Maryland Maze, Stiller, S. D. (1958). Inventory and Accounts Receivable Financing: The Maryland Maze. Md. L. Rev., 18, 185.
Inventory and Accounts Receivable Financing, Greenberg, R. H. (1956). Inventory and Accounts Receivable Financing. U. Ill. LF, 601.