RESOURCES

Accounts Receivable Financing

A revolving line of credit secured by accounts receivable is among the most efficient ways for a company to get the cash it needs for day-to-day operations--to pay bills, increase inventory or meet payroll. By using its accounts receivable as collateral, a company can get a business loan for whatever it needs, for however long it needs it, without taking on extra term debt or diluting its equity. The value of the receivables remains on the borrower's financial statement but is committed as security for the loan. As receivables are paid, the cash goes directly to the lender to pay down the outstanding balance of the credit facility. In turn, as a company needs additional capital, it can continue to borrow against the receivables up to a maximum amount set by the lender. Accounts receivable financing can also benefit fast growing small and mid-sized companies because as sales increase, so too does the maximum credit available to them.

While many companies can benefit from accounts receivable financing, it can be particularly useful to those whose working capital demands swell at certain times of the year, or to companies that find it difficult to obtain traditional business loans. Additionally, because illiquid assets aren't tied up as collateral, a company is free to apply for other types of business loans.

A similar type of financing that uses accounts receivables is factoring. A factor financing entails the sale of account receivables to another company (the factor). The factor then assumes the credit risk for collecting those accounts. In an accounts receivable financing, the borrower guarantees that the lender has the right to the receivables, but if they go unpaid, the borrower is responsible for their collection.

The advantage of factoring is it allows a company to more quickly receive payment from its customers, and it doesn't have to spend resources following up on unpaid invoices. See our Factoring section to learn more about the subject.

Time Frame

It takes about one month to secure accounts receivable financing. The lender will need to see audited financial statements and will review your company's current financial position, particularly the accounts receivable section of your balance sheet.

Amount

To establish a company's maximum line of credit, the value of ineligible receivables is subtracted from total accounts receivable. The balance is your company's borrowing base or the amount available to collateralize the loan. Typically, receivables from foreign customers and receivables that are more than 120 days old or 90 days past due are ineligible for inclusion in the borrowing base. Accounts receivables from customers that comprise a high percentage (10 percent to 15 percent) of total receivables, and that have either a poor credit rating or a risky financial structure, may also be deemed ineligible. The lender will then multiply the borrowing base by a percentage called an advance rate to determine the maximum line of credit. Advance rates typically range between 65 percent and 85 percent.

For example, a company with $100,000 in accounts receivable, but ineligible receivables of $5,000, would have a borrowing base of $95,000. Applying an advance rate of 80 percent, the company's maximum available credit would be $76,000.

Term

Accounts receivable lines of credit are usually extended for a minimum of two years and renewed annually by the lender.

Price

Accounts receivables are liquid and are among the cheapest financing options available to a company. Borrowers typically pay between one percent under and two percent over the prime rate - the interest rate banks charge their best customers. Borrowers may pay fixed or variable rates. Variable rates are subject to review and adjustment at agreed upon periods (often three months, six months or annually), and is stipulated in the lending agreement between borrower and lender.

Security

Lenders closely monitor accounts receivable for changes in the borrowing base. As a company draws down its line of credit, it must issue reports to its lender on the status of its receivables. If the company is considered high-risk, the lender may ask for weekly reports; otherwise, monthly reports are common. The changing health of the company's cash flow may lead the lender to increase or decrease the amount of cash it makes available to the borrower.

Payments by the borrower's customers are sent to a postal box, also known as a lock box. The lender collects the proceeds from the lock box and uses it to pay down the borrower's debt. Each dollar paid on the debt frees up a dollar the borrower can use as credit.

Financial Covenants

Because accounts receivable financing relies so heavily on a company's cash flow, lenders will typically stipulate that a borrower maintain a minimum interest coverage ratio-the ratio of earnings before interest and taxes to interest on long-term debt. This ratio usually ranges from 1:1 to 1.4:1 and is determined by the financial condition of the borrower. Similarly, a maximum debt-to-equity ratio of between three and four to one would be required with this type of business loan.