The Pros and Cons of Financing Accounts Receivables
When it comes to operating a business, needing to get financing is nothing new. Accounts receivable financing is one of the longest-standing types of business funding, and is commonly referred to as “factoring”.
At its core, accounts receivable financing is a process that involves selling certain receivables to a funder to get an early payment. Typically, these receivables are sold at a discount, with fees associated with them. The funder, or “factoring” company, then assumes the risk of collecting on the receivable. The amount of immediate cash given per receivable depends on how old the receivable is and the “quality”.
Age of the Invoice
As was discussed above, the age of the invoice matters when trying to secure financing. Most invoices are payable within about 180 days. If an invoice is newer and has more time to go before being “past due” they usually are more preferable to a potential funder.
Length of the Financing Agreement
Another important aspect of utilizing accounts receivable financing is the length of the agreement you make with the factoring company. Some agreements can go for months (even years). Depending on what you are trying to accomplish in your company, you’ll want to consider the effects of both long-term and short-term arrangements.
In this article, we’ll also cover some of the pros and cons of using account receivables financing to help speed up cash flow.
One of the great pros of this type of financing is that you don’t have to give up equity or ownership in your business to get funding. Another would be that you don’t have to put up any collateral and worry about defaulting. The receivable itself is the collateral.
One of the biggest cons is the loss of flexibility when stuck in longer arrangements. While some agreements can be shorter, most are longer than would be preferred. If you’re savvy though, you can usually negotiate a length of contract that will work for you. Another con is that sometimes these financing options come with high costs. As opposed to other types of business loans, the costs are high. If you don’t pay back the amount within a set period set by the funder, you will likely have to pay more overall.
No matter what type of business you are in, you’ll likely have to engage with business financing of some kind or other. Knowing the pros and cons of each type of financing can help you to make smart business decisions.