Published Jan 22, 2022

Receivables Financing: The Ultimate Guide

Table of contents

Receivables financing may give you cash earlier than your receivables’ maturity,  but it is not that quick. Receivable factoring fees may seem low, but total costs are not that low.

Sometimes known as accounts receivable financing, receivables financing is one way for businesses to unlock money tied up in their accounts receivable, hence getting a cash injection into the company.

To help you learn more about receivables financing, this article covers topics such as what is receivables financing, how it works, pros and cons, and costs of receivables finance. Let’s get started.

  • What is receivables financing?
  • When and why should you get receivables financing?
  • How does receivables financing work? (With examples)
  • Costs of receivables financing
  • Pros and cons of receivables financing
  • Alternative to receivables financing

What is receivables financing?

Receivables financing is a form of financing which allows you to get cash from your accounts receivable.
It is also known as receivables finance or accounts receivable financing.
To lenders and financiers, accounts receivable (AR) are regarded as highly liquid assets that have theoretical value. 
Many business sellers have a different view.
Accounts receivable, which cannot be converted into cash immediately, represent money tied up on companies’ balance sheets. This reason, coupled with the hassle of tracking down customers to pay up, gives businesses an incentive to trade their receivables for cash — that is receivables financing.

When and why should you get receivables financing?

Many sellers have receivables that they cannot wait to collect payment on, hence the need for receivables financing.
If any of the following applies to your business, receivables financing may be a solution to improve your company’s cash position.

1. You sell to customers on long credit terms

Business-to-business (B2B) companies often sell on credit, meaning that customers get the goods now but pay on a later date. 
For example, a “net 30” on an invoice allows your customer to make payment within 30 days of the invoice date. A “net 90” invoice will be settled within 90 days.
Selling on credit gives your customers more flexibility in payment, hence an incentive to buy from you. However, what is good for your customers may not be best for you.
In fact, delayed payments from B2B customers could impede your company’s cash flow. You will have less cash to buy inventory from suppliers, spend on marketing campaigns and other cost items for growth.

2. You sell on third-party e-commerce platforms

Third-party e-commerce platforms like Shopee and Amazon could be your friend or foe.
As a friend, these platforms are easy to use. You could skip the work of setting up your own e-commerce site and start selling quickly.
Yet, e-commerce platforms could be a foe to your company’s cash flow. 
As part of their anti-fraud initiatives, most e-commerce platforms would hold back sellers’ revenue until after buyers have confirmed receipt of the goods.
Depending on the e-commerce platform that you sell on, it could take a few working days to a few weeks for your sales revenue to arrive at your bank account.
Again, the long delay between sales and payment could cause a shortage of working capital and affect the way you deploy financial resources for business growth.

How does receivables financing work? (With examples)

Receivables financing helps your business get a cash injection in two ways. 
You could sell your accounts receivable, or use them as collateral for loans. The former is receivables factoring, and the latter is receivables discounting.
This section explains, with examples, how these two types of receivables financing work.

1. Receivables factoring

Receivables factoring is when you sell your outstanding receivables to a factoring company.
Typically, a factoring company pays you 70-90% of the receivables value upfront. The rest is paid at the maturity date of your receivables, after deducting the factor fee and other fees.
Receivables factoring is an arrangement of sale and purchase, not lending and borrowing. As the factoring company buys your receivables, it will be responsible for collecting money from your customers too.
Following is an example with actual numbers.
Receivables factoring example

  • You sold $20,000 of goods to a customer on credit.
  • You then sell the receivables to a factoring company at a factor rate of 5%.
  • The initial cash advance is 85%, the remainder to be paid upon maturity.

The 5% factor rate is essentially a discount paid for early cash flow. It means that in the end, you will only receive 95% of the $20,000, which is $19,000.
In a receivables factoring arrangement, the factoring company is responsible for debt collection. 
To minimize the risks of customer default, the factoring company will only give you 85% of the receivables value as an upfront payment, which is $19,000 x 85% = $16,150 in this case.
You will collect the remainder, which is $19,000 - $16,150 = $2,850, at the maturity date of your receivables, after the factoring company successfully collects the sum from your customer.
A quick summary of this receivables factoring arrangement is included below:

Table 1
Item Calculation Amount
(a) Invoice value - #20,000
(b) Factor fee (5%) 5% of (a) $1,000
(c) Total to be received (invoice value after fee) (a) − (b) $19,400
(d) Initial advance (85%) 85% of (c) $16,150
(e) Remaining advance (c) − (d) $2,850

Note: Receivables factoring could be recourse or non-recourse. 
In a recourse factoring arrangement, you will have to buy back or replace any non-performing receivable. In a non-recourse factoring arrangement, you will not be responsible for non-paying customers’ debts.
Learn more about recourse vs. non-recourse factoring in our blog article on invoice factoring.

2. Receivables discounting

Receivables discounting is when you use your accounts receivable as collateral to borrow money.
The loan amount usually ranges between 80% and 95% of the receivables value, which you will pay back with interest and fees to the lender upon maturity. 
In receivables discounting, you are not selling your accounts receivable. You simply use them to collateralize a loan. Therefore, you still own the receivables and are responsible for collecting payment from customers.
Here is an example of receivables discounting.
Receivables discounting example

  • You sold $20,000 of goods to your customer on credit.
  • You then secure a 85% loan using the $20,000 receivables as collateral.
  • You will repay the loan (with interest and fees), ideally after collecting payment from your customers.

In this receivables discounting example, you will be given $20,000 x 85% = $17,000 upfront. This amount plus interest and fees will be repaid on or before due dates specified by the lender.

Costs of receivables financing

Interest is a cost of capital known to many. In receivables financing, however, there are many more cost items. Below are some common costs of receivables financing.

1. Origination fee

You may be charged an origination fee for each loan application. It is also known as application fee.

2. Credit check fee

Factoring companies make credit checks on your customers to assess default risks. A credit check fee may be charged to cover these expenses.

3. Factor fee

Factor fee is the discount that a factoring company takes when it buys your receivables. 
Depending on the degree of risk, the factor fee usually ranges between 1% and 5% of the receivables value.

4. Interests

Interests accrue on loans obtained through receivables discounting. The amount varies among financing institutions.

5. Service fee

A service fee may be charged for providing funding to you. It can also come under the notion of a credit management fee.

6. Collection fee

As its name indicates, collection fee is a sum charged by factoring companies for collecting payment from your customers.

7. Overdue fee

If your customers fail to pay up upon maturity of the receivables, factoring companies may also charge an overdue fee from you.

Pros and cons of receivables financing

Advantages of receivables financing

1. Smooth out cash flow

This is the major benefit of receivables financing. 

Receiving cash right away allows quick restock and investment for growth. With receivables financing, you can worry less about managing cash flow and supply cycles.

2. Less hassle from receivables collection

If you go for factoring and sell your receivables, you are also outsourcing the payment collection process to factoring companies. 
Although you may need to pay a collection fee, you could save the time and effort of going after customers for payment, hence freeing up your time to focus on business growth.

3. No other collateral is required.

Traditional loans usually require more expensive assets, such as vehicles, equipment or real estate as collateral. 
On the other hand, receivables financing is accessible by most businesses that have accounts receivable.

4. Little emphasis on your company’s credit history

Receivables factoring and discounting companies care less about your company’s credit history than bank lenders. 
If the lack of stellar credit history is a barrier to financing via traditional routes, receivables financing is something you could try.

Disadvantages of receivables financing

1. Very expensive

While a fixed-rate factor fee (or interest in the case of receivables discounting) does not sound too bad on paper, various fees could quickly add up to an enormous sum.
Unless your company is willing to get a quick cash injection at all costs, you may be better off looking for alternatives to receivables financing.

2. Time-consuming application

Receivables financing gives you access to cash earlier than your receivables’ maturity, and are certainly quicker to obtain than bank loans. But they are not that quick.
There is a lot of paperwork to be done for an application for receivables financing. Rounds of phone calls and e-mail correspondences with the financier are inevitable, too.
Besides, it also takes some time for the financier to credit check your customers and make an assessment. It could be weeks before you really get your hands on cash.

3. May affect customer perception

Your clients will be aware that you have factored their receivables when factoring companies contact them for payment.
Having customers second guess your company’s cash flow conditions is definitely not a good look.

4. Possible deposit account control agreement (DACA)

If you go for a more traditional form of trade finance, you may be asked to sign a deposit account control agreement (DACA)
You may also be asked to switch your company’s bank account to a DACA account where the financier has control over the deposits, which is undesirable.

Alternative to receivables financing

Receivables financing is as expensive as it is accessible. It should only really be considered when there are no other available financing options.
If your business is looking for a quick cash injection for business growth activities, Choco Up provides revenue-based financing (RBF), an alternative financing solution that suits your needs.
Here is how Choco Up answers your business growth needs, and how revenue-based financing eliminates the drawbacks of receivables financing.

1. Application is quick and easy

Having worked with hundreds of fast-growing companies, Choco Up understands the need for quick access to growth capital. 
We therefore strive not to let complicated application procedures get in the way of access to funding.
With Choco Up’s data integration platform, an application for RBF funding could be easily made by sharing key information about your business (e.g. your website, business nature and key markets) or connecting your sales and analytics accounts (e.g. Stripe and Google Analytics). 
In less than 15 minutes, you could get a preliminary offer. Funding could be available in as little as 48 hours if everything goes well. Just sign up for a preliminary offer here and give it a try. It is free.

2. Repayment is flexible

In revenue-based financing, you will be given funding in a lump sum, which will be repaid through a small percentage of your company’s revenue.

While loans require repayments in fixed sums by specified dates, Choco Up does not bind you to rigid repayment schedules.

Revenue-based financing therefore gives you ample flexibility in repayment. You will repay more when you earn more in a particular month, repay less if you earn less. There is no need to worry about keeping up with repayments or overdue payments.

3. We take no more than a small flat fee

Choco Up does not charge fees in different names.

You do not have to worry about hidden fees and potentially high costs of capital, as only a small flat fee is added to the repayment sum.

4. No collateral is needed

Bank lenders ask for expensive business assets, whereas providers of receivable financing need your accounts receivable as collateral.

At Choco Up, we do not require any collateral at all.

For asset-light companies that are unable to satisfy collateral requirements in traditional financing methods, revenue-based financing is a great alternative to consider.

Learn more: What is Revenue-Based Financing? Here is Everything You Need to Know

Receivables financing vs. revenue-based financing

As a quick, flexible, inexpensive and collateral-free funding method, revenue-based financing comes with a great many benefits. In many instances, it is used as an alternative to receivables financing to overcome AR delays.

On top of the features discussed above, it must be stressed that revenue-based financing is non-dilutive, too. It means that by providing funding to you, Choco Up does not take any equity from your company.

For you to better compare revenue-based financing with receivables financing, below is a table of comparison:

Receivables factoring Receivables discounting Revenue-based financing
Availability Businesses with outstanding receivables Businesses with at least US$1 million annual revenue
Collateral Not required Receivables Not required
Application process Slow Quick and easy
Deposit account control agreement (DACA)? Maybe No
Fees Many fees (e.g. factor fee, service fee, collection fee, etc.) Flat fee only
Interest on outstanding balance? N/A Yes No
Repayment No Fixed sum and schedule Flexible (percentage of monthly revenue)
Equity dilution No

Some last words

For most business financing options, there is a trade-off between cost and speed. Quick funding methods often have high costs, whereas low-cost options could have very long turnaround times (e.g. bank loan approvals).

Revenue-based financing is an exception to that ‘rule’, as it gives you quick access to funding at minimal cost. For this, hundreds of companies have worked with Choco Up, leveraging RBF funding to realize their upside growth potential.

To learn more about how Choco Up could help your business grow, check out our client success stories or apply for funding now!

Learn more about financing with us: