Managing a business means having an understanding of different terms that can appear at any time. Whether you need to manage the finances of your business or focus on the successful application of different accounting methods, it is important to be equipped with a detailed understanding of all financial lingo.
Well, a very important concept that you need to be familiar with is receivables finance, and if you are not sure what Receivables financing means, then after completing this blog, you will be thoroughly educated on the subject matter. Get ready to brush up on your financial knowledge through the means of this article.
Introduction to Receivables Financing
As we can decode from the term, Receivables financing or accounts receivables financing is a trade finance method which enables businesses to raise money for different operations of the business, particularly the amount owed by its customers in unsettled invoices. This particular amount is generally called trade receivables or accounts receivables, which is why the funding received is referred to as Receivables Financing.
Through this method, businesses can receive payment earlier than expected, and this allows them to invest this money in the growth of their business. In this particular process, the business will see certain or maybe all the pending invoices to a third party who is known as the financier or funder and receive money in exchange. While there are certain situations where the method incurs a fee, it can provide you with the financial boost that you need to grow your business.
What are the different types of receivables finance?
Before using and factoring trade receivables, you need to comprehend that there are different varieties of receivables financing options. All these options are open to businesses, and they can use any one of them during this financing process.
- Invoice Discounting: Invoice discounting is a comparable method to factoring; however, the firm is still responsible for pursuing unpaid client payments. Hence, invoice discounting typically occurs secretly, with the company’s consumers not always realising that invoice discounting is being practised.
- Factoring: Factoring is a type of receivables financing method where all the pending receivables of a business are sold to a third party. In the majority of the cases, the company will get money between 70% and 90% of the receivables that are sold. Now, the third party, also known as the factor or the financier, will receive money from the customers of the company.
- Asset-based lending: While invoice factoring entails the sale of receivables, asset-based lending (ABL) lets businesses obtain loans based on assets, including accounts receivable. Using additional assets as security—for example, inventory or equipment—ABL can also be protected.
These are the three different types of receivables financing that can be done by companies when they wish to raise funds for different tasks and operations for better growth.
Understanding the working principle of receivables finance
It is known to everyone that when a company sells large goods or services to their customers, they often use credit cards for the same. This means that customers are not required to pay the amount until a particular date in future. This method benefits the customers, but does not provide the suppliers with cash that they need, and it can result in cash inflow issues for the company. It can also pose a challenge to future investments and the growth of the business.
In such situations, receivables factoring or receivables financing can prove to be highly beneficial as the company can simply sell all the unsettled receivables to the factor or the financier and receive money in exchange. By getting early payments before the due date of the invoices, the company can overcome any shortage of cash that they are facing and use this money to buy raw materials and complete other tasks.
The entire receivables financing process has a specific structure that we are highlighting here:
- The seller supplies products to the buyer.
- The seller makes an invoice for the buyer.
- The seller gives the factor the invoice.
- Amounting to 70%–90% of the value, the company received early payment from the factor.
- The buyer pays the bill.
- After subtracting any appropriate charges, the factor sends the seller the remaining balance.
This is the entire structure of the receivables financing method that you need to know about, to use it when you are facing a shortage of cash inflow in your business.
