Small business owners have many options when it comes to financing. We have previously discussed peer-to-peer lending, business lines of credit, and merchant cash advances, to name a few. So what is receivables financing?
What is receivables financing, and how much does it cost?
Receivables are defined as amounts owed to a business – essentially outstanding invoices – and are considered to be assets. In a receivables financing agreement, a business borrows against the amount of its outstanding invoices for cash.
For example, a company may receive an advance for 65-80% of invoices from bankers specializing in this type of financing. Once the invoice is paid off, bankers will pay out the existing balance after collecting a fee – which may be between 3-5% of the overall invoice.
What are the different types of receivables financing?
There are multiple forms of receivables financing that small businesses can engage in. The two main types are:
- Invoice discounting: A loan taken out against the invoice assets. This allows a business to borrow funds against other funds that it is owed.
- Factoring: When a small business sells its receivables to a third party in exchange for funds. This is an actual sale of the assets so the default risk transfers to the financing company.
What does the factoring process look like?
- An invoice is generated once a business sells a product to a customer.
- Rather than wait for payment from the customer, the business sells the invoice to a factoring company.
- The factoring company buys the invoice and remits a percentage of its total to the business, keeping the balance on reserve.
- The factoring company collects payment in full from the company’s customer.
- The factoring company returns the balance on reserve to the business, less a fee for assuming collections risk.
When do businesses engage in receivables financing?
Receivables financing makes sense when a business has structural cash flow gaps—for example, because they are required to pay for their goods (materials, inventory) well in advance of when they will receive payment for the cost of those goods.
Will it build my business credit?
Receivables financing will not build your business credit as third party buyers are not required to report back to credit bureaus.
What are the differences between receivables financing and OnDeck?
- OnDeck offers true business loans up to $250,000.
- OnDeck reports payment back to credit bureaus, so our loans build business credit.
- OnDeck considers cash flow, time in industry, and other factors when assessing a loan. A lender in receivables financing decides to extend credit to a business usually based only on the receivables assets.
When considering the different types of financing available for your business, make sure to evaluate the costs and benefits of each option.
OnDeck is a Google Ventures-backed company with an A+ rating with the Better Business Bureau. The company offers small business loans nationwide to over 725 different industries. For more information about OnDeck small business loans, click here.