And depending on the terms you give to your clients versus the timing related to paying vendors, suppliers, and operating accounts, there can be a gap in the time between when you need the money from a sale done on credit and when you’re actually going to get the money.
This funding gap is primary filled by financing your accounts receivable.
There are two basic ways to do this with a bunch of variations.
The lowest cost for of accounts receivable financing typically comes in the form of a bank margining account where a bank or institutional lender takes security over the accounts receivable, as well as anything else they can get their hands on like inventory and potentially equipment, and offers to advance to the business a certain percentage of the accounts receivable outstanding. The advance rules will vary by bank and each lender will also have lending covenants related to the monthly and annual balance sheet and income statement of the business.
Typically a margining account can only be secured by a well established business with at least three years of operations under its belt and fairly constant level of accounts receivable outstanding over the last 12 month period.
AR margining is primarily for companies that are very stable and not in any type of boom or bust position.
The other main category for accounts receivable financing is factoring or invoice discounting where a finance company is actually acquiring the right to collect the accounts receivable that is owed to your company.
Similar to a margining account, a factoring account provides an advance of accounts receivable outstanding to the business. Also similar to a margining account, most factors will not finance an accounts receivable invoice over 90 days past due.
That’s where the similarities end as there are many different forms of factoring whereas bank margining is fairly consistent from one lender to another.
Factors live more in the boom or bust parts of a business cycle although there can also be factoring that competes directly with the stable market space primarily reserved for margining.
Accounts receivable factoring, for the most part is notification versus non notification factoring. Notification means that your customer makes their payment directly to the factor whereas non notification has the customer still making payment directly to the business, but the payments are deposited into a joint account that the factor controls.
Notification factoring provides greater control to the factor and allows them to finance both highly distressed and high growth situations due to the factors control of collections of a legally completed sale.
There is also recourse and non recourse factoring. Recourse basically means that the factor will charge you back if an account becomes noncollectable, or is not collected by a certain point in time. Non recourse essentially means that once the factor purchases the receivable from you at a discount, that they take responsibility for collection and loss from than point forward.
Each version of factoring has its own business applications and there can be very large differences in pricing from on factoring program to another, largely due to what is being offered in terms of notification, recourse, and size of the transactions being factored as well as the overall facility.
Because there are so many different potential variations to accounts receivable financing, it can be very easy to get focused in on a funding option that is not ideal for your business.
This is certainly an area of business financing and asset based lending where some financing experience can come in handy in terms of both locating a suitable financing source and getting a facility up and running for your business.
If you have an accounts receivable financing need, I suggest that you give me a call and we can go over your requirements together and review different margining or factoring options available to you.