Accounts receivable for a small business is more of an asset than some of you may know. There are two ways you can turn your accounts receivable into a cash flow increase for working for venture capital: pledging or factoring. Each has different terms and payment structure, as well as benefits to the business.
Pledging
Accounts receivable pledging is the process of using these invoices as collateral with a lender that will typically determine the quality of the accounts receivable by the credit terms and the length of payment. These lenders don’t generally lend on past due invoices as there is no value. The risk of the collections is still on the business and the lender has the right to take control of these accounts receivable in the event that the business defaults on repayment. This is where the true cost is seen as the business will only be able to borrow up to 80% of the accounts receivable, losing 100% if the payments default.
Factoring
Accounts receivable factoring is the process of selling these invoices, pretty much cutting ties with the collections altogether. The rates for factoring average around 2-3%, with an advance anywhere from 85-97%, with a reserve held until the invoices are paid. The price is much less as well as the risk for the business as the factoring company is buying these accounts receivable and assume all risk of default on the collections.
So which is better? The actual needs for the financing of the business, the reasoning for the money, the credit-worthiness of the clients, everything should be determined to evaluate whether factoring or pledging is most appropriate. Invoice factoring is a common practice in many industries such as construction, and even retail which accounts for nearly 80% of accounts receivable factoring in the U.S.
Invoice factoring is a practice that can provide great opportunity and even stand in the way of bankruptcy for a small business. Even if the business’s credit isn’t doing so well, factoring could be a perfect solution for cash flow and venture capital that is needed to continue with business operations successfully.
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