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.
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.
Though the eligibility criteria differ with lenders, the ones given below can be considered as the standard requirements:
You will be mostly asked to submit:
Apart from these, you may be required to submit identity, address, business ownership, and financial proof documents if need be.
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.
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.
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.