In typical day-to-day business, goods and services are frequently sold on credit rather than being paid for before or on delivery. This gives rise to the term ‘account receivable’ (AR) or ‘trade receivable’, which refers to an outstanding payment that is owed by a client who has received goods or services on credit. Thus, if a company provides a service or delivers supplies to a client on a specific date with the agreement that the client will pay after 30 days, then the company has an account receivable for those 30 days. In contrast, the client will have an account payable.
How do account receivables apply to accounting?
When a company has an account receivable, the total amount owed is recorded under the AR section in their general ledger. This outstanding payment is grouped along with other current assets, e.g. cash that the company owns since, all things being equal, the company fully expects their client to settle the payment. However, the client may not fulfil the agreement, which introduces a risk factor that requires companies to exercise caution before opening an account receivable. If a customer has a dubious credit history, then it is more prudent to request an upfront payment before the provision of goods or services can be carried out.
How does accounts receivable finance work?
Accounts receivable finance is a type of factoring that enables companies to receive all outstanding payments owed by their clients in advance. Companies can achieve this by “exchanging” their invoices for money that is received from a selected funder. Thus, companies can secure early payments on their accounts receivable for a fee. The process is simple; once a company completes a transaction, the company also forwards a copy of the invoice received by the customer to the finance provider. The finance provider quickly pays for the invoice (usually within 24 hours) with the advance amount being approximately 85% of the total amount stated in the invoice.
Factoring vs. Lending
Accounts receivable factoring should not be confused with lending or loaning. Strictly speaking, it is a way to purchase assets (cash or money) that are tied up in unpaid invoices. During the process, the finance provider assumes control over the company’s credit accounts which enables them to screen customers according to their creditworthiness and to carry out collections for the benefit of the company.
Advantages of accounts receivable factoring
It can prove highly beneficial to the wellbeing of most companies since companies do not have to be held hostage by factors such as whether a customer will pay and if they do, will the payment be on time. Instead, companies can secure their financial affairs through better management of cash flow and capitalizing on other opportunities that require working capital. This means a company can pay staff wages, suppliers and additional costs as well as maximize profits without the worry that comes from outstanding payments.
How can accounts receivable factoring be used effectively?
This type of facility applies to many areas and instances of business requiring a financial push. It is useful when:
There is limited cash flow for expansion
Growth in business is significantly reliant on adequate cash flow. Hence, the funding received from accounts receivable finance can be used as a springboard that will launch more considerable expansion by allowing companies to settle their bills (suppliers, salaries etc.) and build their client list.
There is a need for fast funding
Funding can be quickly received once the application is made. This is particularly desirable for those times when there is a necessary expense that needs urgent attention. Fast funding is not readily available but accounts receivable finance providers can provide much needed cover within 24 hours when possible.
The company is not eligible for a bank loan
Accounts receivable finance takes into account your customer’s creditworthiness, whereas banks also analyse other areas of your business such as past performance, bank balance etc. This means it can be tougher for companies to get a bank loan or other forms of finance if they need it but accounts receivable finance has more flexible eligibility terms.
Credit control processes are limiting business expansion
While accounts receivables are a normal part of business operations, they can turn into complications that consume time and other resources when the customer doesn’t pay as per the agreement. Committing the outstanding invoices to a finance provider leaves companies with more time to pursue their business expansion goals without worrying about credit control and collection procedures.