Is Selling Accounts Receivable Right for Your Business?
There’s more to business than just maintaining stable cash flow, but that doesn’t mean it’s not important! If your business needs working capital, you might be looking at all your options, including selling accounts receivable. As with any big decision, it’s important to have a thorough understanding of the pros and cons of this type of financing so that you can make an informed decision about whether or not selling accounts receivable is right for your business. In this article, we’ll cover the question of whether you should sell your receivables and what to look for when comparing companies that buy receivables – all so you can make the most informed decision for your business.
The Problem With Extended Payment Terms
Small businesses that sell their products and services to commercial clients often have to offer extended payment terms. These big businesses usually take 30 to 60 days to pay, but this period is longer for certain industries. (Oil and gas companies, can take up to 90 days (or longer!) for payment.) Waiting months to get paid has a significant impact on your cash flow. Even if you’re stuck waiting on payment, you still have to:
- Cover payroll
- Hire staff
- Buy or maintain equipment
- Purchase inventory
- Pay subscriptions, utilities, and other critical bills
And you might want to:
- Accept big projects to grow your business
- Enhance the balance sheet with cash-on-hand for potential investors
Of course, if you then have to deal with a late payment, the cost of collections can balloon. At the same time, it’s challenging to take advantage of early payment discounts when you are waiting for outstanding receivables. This cash crunch severely limits business growth.
On top of that, many small businesses struggle to secure a funding source such as traditional bank loans or lines of credit, leading them to explore alternative funding solutions.
Why Small and Medium Businesses Struggle to Get Funding
Most small and medium-sized businesses find themselves locked out of traditional lines of credit and other financing options, even when they have paying customers and a sound business plan – or, they’ve reached their limit on an existing line of credit. Some reasons why SMBs struggle to secure traditional financing include:
- Time in business. Banks often won’t approve small and medium businesses for business financing unless they have a proven track record of success — something that doesn’t come for a couple of years, at least.
- Time-sensitive business opportunities. Even if you have a solid track record, the process of securing funding from a business bank can take weeks or even months. The opportunity you needed the cash for may have passed by that time. Same goes for even simply raising the limit on your line of credit. It can take weeks to approve a modest credit increase, that’s if you meet the bank’s stringent requirements (and submit a pile of paperwork.)
- Asset collateral. Some forms of financing require collateral, giving up equity, or long-term commitment. These methods for getting cash flow funding fast can be risky, with convoluted contracts and hidden fees.
Small businesses need a way to access cash quickly without the stress and long-term commitments associated with traditional credit options.The good news is that today it’s easier than ever for small business owners like you to get the financing they need. How? By selling accounts receivable to a third party.
What Does Selling Accounts Receivables Mean?
Selling receivables is an alternative financing option commonly known as invoice factoring, receivable financing, or financing receivables. In a nutshell, invoice factoring is a type of receivables financing where you sell your accounts receivable (a.k.a., your outstanding invoices) to a third-party financing company, also known as a factor, at a discount. In return, the finance company provides you an advance payment of the value of the invoice, minus a fee, then works with your clients to collect payment according to the original invoice terms. It is a short-term financing option.
The Process of Selling Accounts Receivable
Once you are approved for funding, the receivable factoring process is simple:
- The factoring company buys the invoice, then verifies the details, and works with you and your customer to redirect payment.
- You receive a portion of the invoice, usually 70-90%, ahead of the net terms. (At FundThrough, you get up to 100% of the invoice amount in days.)
- Your client pays the invoice amount to the factoring company according to the original net terms. You don’t have to worry about chasing down payments or managing the collections process.
- When your customer pays the invoice, the factoring firm deducts their factoring fee (known as the advance rate) and remits the remaining amount to you.
- You can then repeat the process with additional customer invoices as needed to maintain a healthy cash flow.
There are two types of receivables factoring: recourse and non-recourse. Recourse factoring simply means your company must buy back any invoices the factoring company is unable to collect payment on. Selling accounts receivable without recourse means the factoring company assumes most of the risk of non-payment by your customers – however, this option is more expensive.
Why Would a Company Sell Their Receivables? Here Are 4 Reasons
You might ask yourself, why would I sell my receivables? That’s a fair question. Not every business needs to sell their receivables, but for some companies receivable financing makes sense. The reasons below are just some of the common reasons our clients tell us they choose to sell accounts receivable. Consider them in the context of your own unique situation to make a decision.
1. You need quick and easy financing for rapid growth (or anything else)
The right invoice factoring solution should provide a speedy way to apply for and receive cash. Thanks to AI, automation, and integration with accounting software, FundThrough eliminates the time-consuming paperwork and approval process associated with business loans and other financing options, speeding up your access to working capital.
2. You need flexibility with no long-term commitments
You tap into cash only when you need it and choose the invoices you want to fund, when you want to fund. Take something you already have – unpaid invoices – and turn it into a tool for cash flow—all without committing to longer-term debt. Just make sure your factoring partner doesn’t require any long-term factoring contracts, or monthly minimum factoring volume.
3. You want funding without debt
Because factoring is not a loan, you aren’t adding any debt expenses to your balance sheet. Additionally, you aren’t giving away any equity in your business, so you remain in complete control of your company with this non-dilutive source of funding.
4. You want to avoid bank financing hassles
To secure a traditional loan or other bank financing for businesses, you’ll have to jump through hoops including a lengthy approval and application process. Banks also require you to have a certain credit rating or credit score in order to qualify for funding. Receivable factoring focuses on the creditworthiness of your customers, and many factoring applications can be completed in just a few minutes online. Getting approval for factoring in a matter of days is just one of the major benefits of factoring compared to applying for bank financing.
Can accounts receivable be sold?
Yes, accounts receivable can be sold through a process called factoring, which is a type of receivable financing where a company sells its outstanding invoices to a factor at a discount in exchange for immediate cash.
What are the advantages of selling accounts receivable?
The advantages of selling accounts receivable include: quick access to working capital without creating debt, streamlined business operations, improved cash flow issues, no more late payments, and easier to qualify for than traditional bank funding.
What is the journal entry for selling accounts receivable?
The journal entry for selling accounts receivable depends on whether the company is using factoring or a similar financing arrangement. See our post on accounting for factoring receivables to learn how to record factoring transactions.