Cash flow is the lifeblood of any business and, to ensure liquidity, businesses often need to borrow over the short time. However, a lack of collateral can often make that difficult, especially for newer companies.
Accounts receivable financing uses unpaid invoices as collateral, making it a form of credit exceptionally well suited to solving the issues caused by late payment of invoices.
This article will explain exactly what AR financing is, the different types of AR financing available and its benefits and drawbacks.
What is accounts receivable financing?
So, what is AR financing? In finance, AR stands for "accounts receivable." Accounts receivable are the money that a company is owed by its customers for goods or services that have been delivered but not yet paid for.
Accounts receivable (AR) financing is a type of financing that allows businesses to borrow money from receivable financing companies using their outstanding invoices as collateral. They are short-term accounts receivable loans that are typically repaid when the invoices are collected.
Generally, accounts receivable financing is based on the value of the outstanding invoices, with the lender advancing an amount of the outstanding invoice and charging interest until the repayment is made. You might be wondering whether accounts receivable are debit or credit—it's considered a debit because it represents an amount the company expects to receive.
Loans on accounts receivable can be a helpful financing option for businesses to access working capital and improve cash flow.
How does accounts receivable funding work?
While the exact process for applying for, and receiving, accounts receivables loans, depends on the loan provider, below is overview of standard process:
- Invoice your customers
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- Businesses provide goods or services to their customers and issue invoices for payment. These invoices typically include details such as the invoice number, invoice date, customer's name and address, description of goods or services, quantity, unit price, total amount due, and payment terms.
- Submit Invoices for financing
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- Businesses that need immediate access to cash can submit their unpaid invoices to a lender or financing company specialising in accounts receivable lending. The lender evaluates the invoices to assess the creditworthiness of the customers and the overall risk of the transaction.
- Lender advances funds
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- Once the AR loans lender approves the financing request, it advances a percentage of the total invoice value to the business. The advance rate typically ranges from 70% to 90%, depending on factors such as the industry, customer's credit history, and the lender's risk assessment. The remaining percentage serves as a reserve to cover potential bad debts or disputes.
- Business receives funding
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- The business receives the funding from the lender, which can be deposited directly into its bank account. This funding can provide immediate liquidity to the business, allowing it to meet various financial obligations, such as paying suppliers, employees, or operational expenses.
- Customers pay invoices
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- The customers of the business make payments directly to the lender or financing company, as specified in the invoice. The lender typically provides instructions for payment, including the payment address, account number, and any applicable reference numbers.
- Lender collects funding plus interest
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- Once the lender receives payments from the customers, it deducts the original advance amount and any applicable fees or interest. The remaining balance is then remitted to the business, completing the financing accounts receivable transaction.
- Repayment of loan
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- The business is responsible for repaying the loan against receivables to the lender, typically within a predetermined period specified in the financing agreement. This repayment period can range from 30 days to 90 days, depending on the terms negotiated between the business and the lender.
6 benefits of AR funding
For companies dealing with the current late payment crisis, accounts receivables loans can have a wide range of benefits, including:
1. Improved cash flow
AR funding can provide businesses with immediate access to cash, which can be used to meet various financial obligations, such as paying suppliers, employees, or operational expenses.
AR funding not only improves cash flow but also supports better accounts receivable management. By ensuring quicker collections and reducing reliance on credit, businesses can maintain healthier financial operations.
2. Not counted as debt
In a well-structured arrangement, selective receivables financing remains separate from a company's financial statements, ensuring that it does not affect outstanding loans or future needs for credit lines and related funding sources.
3. Reduced reliance on traditional lending
Businesses that have difficulty obtaining traditional loans due to a lack of collateral, have poor credit scores, or a short operating history may find AR funding to be a viable alternative.
4. Simplified application process
The application process for AR funding is typically less complex and time-consuming compared to traditional loans, making it a convenient option for businesses seeking quick access to capital.
5. Flexible repayment terms
AR funding typically offers flexible repayment terms, allowing businesses to align their repayment schedule with their cash flow cycles.
6. Potential for increased sales
By improving cash flow and reducing the risk of late payments, AR funding can enable businesses to invest in growth opportunities, such as expanding their product lines or entering new markets.
3 types of AR financing
There are a range of accounts receivable funding options on the market. Three of the most common options include:
Invoice factoring - Invoice factoring is a type of AR financing in which a business sells its accounts receivable to a third-party factoring company at a discount. The factoring company then assumes the responsibility of collecting payment from the customers.
Asset-based lending (ABL) - Asset-based lending is a type of financing that uses a company's assets, including its accounts receivable, as collateral for a loan. Asset-based lenders typically offer larger loan amounts and longer repayment terms than other types of AR financing.
Supply chain finance - Supply chain finance is a type of AR financing that involves a collaboration between a business, its suppliers, and a financial institution. The financial institution provides financing to the suppliers, and the business agrees to pay the suppliers early in exchange for a discount.
Potential risks involved in accounts receivable finances
As with all forms of financing, there are drawbacks associated with loans on accounts receivable which need to be taken into account. These include:
- Credit risk: There is always the risk that customers may default on their invoices, which can result in losses for the business. It’s important to assess the payment behaviour of your customer before using their outstanding invoices as collateral to get an idea of the potential risk.
- Interest rates: The interest rates on AR financing can be higher than those on traditional loans, which can increase the cost of borrowing.
- Covenants: AR financing agreements often include covenants that restrict the business's ability to take on additional debt or make other financial decisions. This reduces the risk profile for the lender, but can also reduce your businesses ability to grow and expand.
- Loss of control: When a business sells its accounts receivable to a factoring company, it gives up control over the collection process. This can make it more difficult for the business to resolve disputes with customers or collect on overdue invoices.
- Reputation risk: If a business uses AR financing, it may be perceived as being financially unstable. This can damage the business's reputation and make it more difficult to attract customers and suppliers.
Accounts receivable financing example
To give you an idea of what the process for using accounts receivable lending looks like, below is an example of how a fictional company might make use of accounts receivable financing to overcome cash flow issues caused by outstanding invoices:
XYZ Company is a small business that sells widgets to other businesses. The company has $100,000 in outstanding invoices that are due within the next 30 days. XYZ Company needs to make a large purchase of raw materials in order to fulfill a new order, but it does not have the cash on hand to do so.
XYZ Company applies for accounts receivable financing from a lender. The lender reviews XYZ Company's financial statements and invoices and approves a loan of $80,000. The lender advances the $80,000 to XYZ Company, which uses the funds to purchase the raw materials.
XYZ Company's customers pay their invoices to the lender, which then deducts the $80,000 loan amount and any interest and fees from the payments. The remaining balance is remitted to XYZ Company.
XYZ Company uses the funds from the accounts receivable financing to pay its suppliers and other expenses. The company is able to fulfill the new order and generate additional revenue.
How much does accounts receivable financing cost?
The cost of accounts receivable financing varies depending on a number of factors, such as the lender, the size of the loan, the creditworthiness of the customers, and the repayment terms. However, as a general rule of thumb, businesses can expect to pay an interest rate of between 1% and 5% per month on their outstanding balance.
In addition to interest, lenders may also charge origination fees, which are typically a percentage of the loan amount. These fees can range from 1% to 5%.
Other potential costs associated with accounts receivable financing include:
- Late payment fees
- Returned check fees
- Collection fees
- Legal fees
It is important to factor all of these costs into your decision when considering accounts receivable financing.
Key takeaways
- Accounts receivable (AR) financing, also known as invoice financing or factoring, is a type of financing that allows businesses to borrow money against their outstanding invoices. It is a short-term financing solution that can help businesses improve their cash flow and meet their financial obligations.
- Under AR financing, businesses can submit their unpaid invoices to a lender or financing company, which then advances a percentage of the total invoice value to the business. The customers of the business then make payments directly to the lender, and the lender collects the funding plus interest. The remaining balance is remitted to the business, completing the financing transaction.
- AR financing can be beneficial for businesses that have a large volume of outstanding invoices and need immediate access to cash. It can also be helpful for businesses that have customers with slow payment terms. However, it is important to carefully consider the costs and risks associated with AR financing before deciding if it is the right option for your business.
FAQs
To help you fully understand how accounts receivable financing works, the credit control experts at Chaser have collated and answered the most common questions on accounts receivable loans:
What is a financing receivable?
A financing receivable is a loan that is secured by a company's accounts receivable. This type of financing allows businesses to borrow money using their outstanding invoices as collateral. The lender typically advances a percentage of the value of the invoices, and the business repays the loan as its customers pay their invoices.
Can you borrow against accounts receivable?
Yes. Specific lenders offer accounts receivable financing, which makes use of outstanding invoices as collateral against advanced funds.
What is the accounts receivable financing agreement?
An accounts receivable financing agreement is a contract between your business and an AR funding lender that sets out the obligations of both parties, the amount advanced, the invoices used as collateral, the interest rates, repayment schedules, and other critical details.
What is the difference between accounts receivable financing and factoring?
Accounts receivable financing and factoring are both types of financing that allow businesses to borrow money against their outstanding invoices. However, there are key differences between the two options.
Accounts Receivable Financing
- Lender advances a percentage of invoice value to the business.
- Business remains responsible for collecting payment.
- Lender may have recourse to the business if a customer defaults.
- Typically a short-term financing solution.
Factoring
- Factoring company purchases invoices at a discount.
- Factoring company assumes responsibility for collecting payment.
- Factoring company typically has no recourse to the business.
- Can be a long-term financing solution.
The best option for a business depends on their specific needs, such as immediate access to cash and risk tolerance.
How does selective receivables finance work?
Selective receivables finance is a type of accounts receivable financing that allows businesses to borrow money against a portion of their outstanding invoices. This type of financing is typically used by businesses that have a large volume of invoices but only need to borrow money against a small portion of them.
What is the best accounts receivable software?
Accounts receivable software is a tool that helps businesses manage and automate the process of tracking and collecting payments owed by customers. It streamlines the invoicing process, monitors overdue payments, and provides reports on outstanding balances. To see the top AR solutions check our comprehensive list of best accounts receivable software in 2025.
