Virtually all businesses have receivables and payables. Receivables are accounts that owe money to the business while payables are accounts that the business owes money to.
Receivables are an asset and as such can be used as collateral to secure a loan. Collateral refers to an asset or source of funds that can be used to repay the loan if need be. That's why receivables financing is considered to be a type of asset-based lending.
Collateral typically isn't a dollar-for-dollar match to a small business loan, and the same is true for receivables financing. Instead, the lender will discount the value of the receivables to take into account the cost of collections and accounts that might never be paid.
Receivables can also be sold outright, albeit at a discount, to raise cash for a business. This option is sometimes called "factoring."
Receivables financing can be a lifeline, providing needed cash quickly to keep a business operating, improve cash flow, and help the owner manage and expand business activities.
It also can be especially attractive for startup businesses that might have strong sales, but no track record of success that's required to obtain other types of business loans.
Borrowing against receivables or selling them outright isn't free. Instead, the business will incur some sort of cost whether it's interest expense, discounted accounts (known as "the factor"), or fees for collections services.
Some major banks offer receivables financing, and many smaller specialty lenders buy receivables or make loans against receivables.
Business owners should shop around and compare their options before they make a decision about how to unlock the value of receivables on their books.
Rather than using receivables to obtain financing, some business can improve their collections of their own outstanding accounts. Bringing in money faster from slow-paying customers can improve a business's cash flow and reduce the need to borrow money.
Businesses should define their payment terms, whether that means 10, 15, or 30 days or longer, and take action to collect a debt as soon as an account is overdue. Wait longer and the chances that the account will be paid begin to diminish quickly. Try to get at least a partial payment immediately and set up payment plans with customers who haven't paid.
Don't sell more products or services to customers who haven't paid as agreed. These customers might have financial difficulties and never pay. In some cases, an attorney, collections agency, or small claims court might be necessary to collect receivables.
Companies that purchase receivables may share information about accounts that are uncollectable so the business can avoid those customers in the future.
Speedy collections not only bring in cash, they're also important because businesses might not be able to use old accounts as collateral for financing, closing down that option.
If receivables are a fact of life for a business, receivables financing can be a good way to manage cash flow and keep the business operating while unpaid accounts are collected.