Business Accounts Receivables Financing for Suppliers in India

Revenue from sales is an essential driver of business operations, but there are times when it takes longer than desired to receive payment after goods are shipped.

If the seller needs the proceeds from sales to fund ongoing operations or future growth, the lack of immediately available cash can come in the way of such objectives. To overcome this challenge, businesses use accounts receivable (AR) financing.

What is Accounts Receivables (AR) Financing?

Accounts receivables are the invoices/payments that a company is yet to receive for the goods or services it has already sold. Usually, it is recorded as a current asset on the balance sheet. Among all current assets, it is considered the most liquid asset after cash. Hence, it can be easily used as collateral for borrowing funds.

Accounts receivable financing is when the company receives funding from a bank or a third party by keeping a portion of its account receivables as collateral. Here the bank or the lending firm will not lend the entire amount but a fraction of the amount, say 70-80% of the receivables.

What Factors are Taken Into Consideration While Getting Accounts Receivable Financing?

Many factors are considered before a financing firm decides to enter into a financing agreement with a business. This includes the terms of the deal made between the exporter and the importer and the status of the account receivables, among others.

Compared to invoices from small businesses or individuals, accounts receivable from major enterprises or companies are worth more to lenders. They also typically prefer recently raised invoices over older ones. Hence, the older receivables will potentially result in lower financing amounts compared to the newer ones.

Additionally, a business only chooses accounts receivable financing if they have good relations with their debtors. If the debtor’s ability to repay is uncertain, the borrower can get caught between their debtor and lender.

Why Should a Company opt for Accounts Receivable Financing?

There are various reasons why companies opt for AR financing. The most common reasons include the following:

Faster Cash Traditional loans may take time to get approved and the cash to reflect in the business's account. With account receivables financing, the process is relatively quicker. Companies providing accounts receivable financing generally have everything they need to disburse loans quickly. They don’t need to spend long trying to determine a business’s creditworthiness but only need to verify the trade agreement and the invoice details.

Absence of Credit Score Requirements With AR financing, the financing companies are more interested in the customer's credit history than the borrower’s. Since the customer directly makes the payment, the financing firm checks the customer's credit history to check if they can pay on time.

An Alternative to Deepening Debt When a business takes any loan or even a line of credit, it is shown as a liability in its balance sheets. With accounts receivable as the collateral, companies keep their assets as collateral which does not necessarily come under liability.

Even if it does, it is a minimal amount since account receivable financing options give 70-80% of the entire payment to be received. Thus, AR financing is a favorable option for businesses looking for financing without going deeper into debt.

Types of Accounts Receivable Financing

Accounts receivables can be used to secure financing in two ways, either by selling the receivables or by using the receivables as collateral for loans.

Selling of Assets This is when a company decides to "sell" its account receivables to a third party, transferring the risk to them. Here, the lender takes up the responsibility of recovering the receivables from the customer. A few types of AR financing that come under this method are:

Factoring Factoring is when a business sells its invoices to a factoring company. This third-party company buys the invoices at a discounted price, i.e., 70-80% of the initial value. The factoring firm then collects this payment from the consumer directly in full. Once they deduct their fees from the amount they receive from the customer, they pay the balance to the business.

Companies usually use factoring when they have fluctuating cash flow due to unpaid invoices. It helps improve cash flow, particularly if they are operating in fast-growing industries.

They can also use factoring for turnarounds, during which getting funding from banks can be difficult. Hence, this option seems an excellent way to finance such situations. Learn more about factoring in this post.

In factoring, recourse may or may not be an option, i.e. the borrower may or may not be held responsible for the debts if the customer fails to pay.

The lender and borrower can decide this before signing a factoring agreement.

Also, Factoring is also a good option for small businesses that find it difficult to get loans from banks.

Forfaiting When a business sells its medium or long-term accounts receivables on capital goods, it is called forfaiting. The forfaiter can either be a financial institution or even just a department in the bank. The main difference between forfaiting and factoring is that forfaiting is done only in international trade.

Additionally, while factoring may or may not come with recourse, forfaiting is available on a without-recourse basis, ie, the factor absorbs the entire risk. Hence, forfaiting costs are usually higher than other options since it practically eliminates the risk of non-payment for the exporter.

Forfaiting is an option that is primarily employed in the US by large and medium-sized businesses that conduct transactions over $100,000 and provide 100% financing for the goods they sell.

Using Assets as Collateral for Loans Businesses can also avail loans using their account receivables as assets. In this process, the companies can retain their account receivables in their books compared to when they sell them for funding.

Asset-Based Lending Asset-based lending, simply put, is a loan that businesses take by keeping their assets or AR as collateral. If they are unable to repay the loan, the bank or lender can seize or take ownership of the company's assets used as collateral.

Businesses usually opt for asset-based loans or line of credit to secure working capital. They do so because it is easier to obtain than other lines of credit and loans.

It is another way in which businesses can opt to put their assets to use. If the company has invested in new equipment or inventory, these can be used to secure an asset-backed loan, thereby augmenting the working capital for the business.

Bill Discounting Bill discounting is when a loan is secured against outstanding invoices. Bill discounting companies help businesses to avail necessary funds when they need them from a third-party rather than waiting for 30-120 days until the payment is made by the customers. Just like factoring, the lender often issues loans that are smaller than the invoice value.

Is Accounts Receivables Financing a Long-Term Or Short-Term Financing Arrangement?

AR Financing is a short-term financing arrangement. It ranges from a few days to an entire calendar or fiscal year.

An accounts receivable financing option is merely another tool in the company's working capital. It frequently functions best when combined with dynamic discounting and other supply chain finance options as part of a larger working capital management plan. The company's goals will determine how it will use the receivables, with the ultimate goal being financial growth.

FAQs on Accounts Receivables Financing

1.How does accounts receivables affect a company’s financial statement?

In a company’s cash flow statement, an increase in accounts receivable leads to a decrease in the company’s net income, and a decrease in accounts receivables typically means an increase in net income. However, accounts receivables can also be written off the books if they cannot be recovered from debtors, in which case it doesn’t add to the net income.

2.Are loans considered accounts receivable?

No, loans are not considered as accounts receivable.

3.What does pledging accounts receivable mean?

When a business pledges its accounts receivable, it means that the business is using its accounts receivable as collateral for loans.