Accounts Receivable Financing—An Alternative to SME Loans

Updated on: Jan 11th, 2024


5 min read

Many small and medium businesses operate through a credit system to keep up goodwill with their customers. However, if 9 out of 10 transactions happen on credit, it will put the business on a tight spot in terms of cash flow. It may further affect your inventory purchase and payment of rent and salaries to the staff. One way to handle the situation is to get financing on your business’s account receivables.

What is account receivable financing?

When your business is in a tight spot with a cash crunch, and you need some liquidity, instead of getting a business loan, you can choose accounts receivable financing. Also known as receivable funding, the concept refers to business funding that uses its accounts receivables to obtain capital. There is a similar concept called accounts receivable factoring.

Though some lenders would require you to sell the accounts receivable to them to raise funding, others use them as collateral to give away cash. In India, most lenders provide a loan based on the accounts receivable as collateral or guarantee.

The most significant advantage of following this method to raise some working capital is that there is no negative impact on the credit rating, nor will it be recorded on your credit history. On the other hand, you can expect only up to 90% of the accounts receivable for funding. This may affect your net income and balance sheet.

Features and benefits of accounts receivable financing

  • Loan amount: Based on the accounts receivable, lenders may finance up to Rs.30 lakh.
  • No need for security: You don’t have to provide any assets or properties as collateral or security to secure financing. Accounts receivable is all that is required.
  • Flexible structure: In the case of accounts receivable financing, some lenders allow you to withdraw only the amount that is immediately required and repay the withdrawn amount. You can again withdraw whenever you need it.
  • Credit protection: In the case of factoring, you sell the accounts receivable to the lender rest assured that you had received cash instead that the transaction has protected you against your customer defaulting on the payment.
  • Online services: You can seek financing online since many lenders have established their presence and offer services on their official websites.

Eligibility criteria

Though the eligibility criteria differ with lenders, the ones given below can be considered as the standard requirements:

  • Applicant must be aged between 25 years and 55 years.
  • Minimum experience of three years in running the business.
  • Latest income tax returns filed for the business.

Documents required

You will be mostly asked to submit:

  • A copy of your accounts receivable/invoice.
  • Proof that you have supplied the order.

Apart from these, you may be required to submit identity, address, business ownership, and financial proof documents if need be.

Frequently Asked Questions (FAQs)

Why should I choose accounts receivable financing over a term loan?

Accounts receivable financing can be the preferred choice as compared to a term loan as there is no need to pledge any asset. There is no need for collateral in the former case, whereas collateral is a priority when you apply for a term loan. Also, the latter may have stringent eligibility criteria regarding business turnover and other factors.

How is accounts receivable financing different from factoring?

When you just show the accounts receivable to get financing, it is accounts receivable financing. Whereas, if you sell your accounts receivable to a lender for financing purposes, then it is called factoring.

Will the customer be aware of this kind of arrangement?

In cases where the business owner sells the accounts receivable/invoice to the lender, the lender keeps the customer notified regarding the arrangement and informs that the payment must be made directly to the lender. There may be times when the customers are unaware of the arrangement and payback to the business owner. In that case, the payment must be forwarded to the lender in either case of financing and factoring.

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Quick Summary

Accounts receivable financing is a way for businesses to obtain capital by using their accounts receivables. It provides liquidity without affecting credit ratings. Lenders may finance up to Rs.30 lakh based on accounts receivables without requiring collateral. It differs from factoring where accounts receivables are sold. Eligibility criteria and required documents vary among lenders. FAQs explain the difference from term loans and factoring, and customer awareness of the arrangement.

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