Apart from fixed assets, accounts receivable are one of a business’ largest assets. A large AR balance is both a blessing and a curse. Increasing AR means that sales are coming in, but AR is just numbers on a piece of paper.
A lot of cash gets tied up in accounts receivable. It will be weeks or even months before you see the cash from those sales. Short of very aggressive collection efforts, there isn’t much a business owner can do on their own to get that money in fast.
But, if you’re willing to get a third party involved, there are many ways to convert accounts receivable into cash prior to the invoices being paid. One of those ways is through invoice discounting.
What Is Invoice Discounting?
Invoice discounting is a form of commercial financing that uses your accounts receivable as collateral. It allows a business to receive cash from sales before invoices are paid.
The amount you are able to draw will increase or decrease based on the balance of your accounts receivable. Typically, a lender will advance up to 80% of eligible accounts receivable. That means if you have $1 million in AR, you could draw up to $800,000. That $800,000 is then repaid as you receive payment from your customers.
In turn, as you continue to invoice you can request additional advances from your lender. On the other hand, if you have adequate cash to meet your immediate needs you need not take an advance.
How Does Invoice Discounting Differ From Factoring?
Both are forms of receivables financing; however, there are a few key differences. With factoring, your receivables are assigned to the factoring company. Invoice discounting is a line of credit where the receivables are used as collateral. You keep the responsibility of your accounts receivable collection.
With factoring, the factor sends invoices to your customers and your customers remit payment to the factor. When an invoice is paid, the remainder of the invoice is sent to you, less the fee charged by the factor.
With invoice discounting, you continue to invoice your customers and your customers are never aware of the financing arrangement. The funding you receive is based on the total outstanding balance of your accounts receivable.
Factoring fees are typically charged on an invoice-by-invoice basis and are determined by the time it takes for the invoice to be paid. Invoice discounting carries a traditional interest rate and may carry monthly fees as well.
Benefits Of Invoice Discounting
Improve Cash Flow
As with any type of receivables financing, the biggest benefit is that it will improve your cash flow. The longer your customers take to pay, the greater of a benefit this is. Cash flow is a function of the amount of cash coming in minus the cash going out. This type of financing arrangement brings cash into your account as soon as you invoice.
Another benefit is the flexibility that this type of financing provides. It gives you control over the amount funding your receive which in turn gives you direct control over the amount of interest you pay. Unlike a term loan from a bank, you request funds as you need them, only paying interest on the amount drawn.
Undisclosed To Your Customers
Your customers never have access to the confidential details of invoice discounting. In fact, the finance company typically does not have any contact with your customers. In cases where your lender does need to communicate with your customers, it is usually done via an anonymous audit company.
Consider the pros and cons as they relate to your specific business to see if this is the right type of financing for you.
Fast A/R Funding specializes in helping small businesses bridge the cash flow gap with factoring. Download our informative “Factoring 101” guide, or call 888.833.2286 to speak with one of our small business finance consultants.