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A Small Business Guide to Accounts Receivable Financing

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There are a few ways to get funding based on your accounts receivable balance. Read on to learn how they work and if they’re right for your business.

Many people have a healthy fear of banks. I certainly do, and I’ve worked at several. This fear is very inconvenient when your business is in need of financing and you start to look for a small business loan.

Luckily, there are several non-bank financing options you can take advantage of. You can push off paying your suppliers. You can get an advance from your merchant services company. Or you can utilize your accounts receivable (AR).

Overview: What is accounts receivable financing?

Accounts receivable financing is when you either sell your receivables straight up or use the balance to secure a short-term business loan.

The key difference between underwriting for AR loans and alternative business loans is that there’s no focus on the income statement. The lender knows they will get the receivables if you default, so they don’t need to make sure you can make the payments.

Types of accounts receivable financing

Here are the main ways you can use your AR for financing.

Invoice financing

Invoice financing is very specialized. In five years of banking, I only looked at one potential invoice financing deal. Usually, a startup gets an order that’s substantially larger than anything it has ever fulfilled before, and there’s no way it can finance manufacturing the product on its own.

So the startup goes to a lender to get a one-time loan to purchase materials and pay for labor until the customer starts making payments. The lender spends some time underwriting the startup, but most of the time is spent underwriting the customer because if the startup defaults, they will need to go to the customer to collect.

The more specialized financing gets, the more expensive it is. Invoice financing should only be used for one-off occasions if your company has no other option.


Factoring companies are also specialized. Instead of financing one invoice, factoring companies will purchase receivables from you for a percent of the total amount. Some are sophisticated enough that they sync with your accounting software and let you pick and choose accounts to sell to them.

Factoring can help you get quick cash, but you may want to build some of the premium into your pricing. Every AR you sell for 90% of its value puts you at a 10% loss right away.

Line of credit

The most common type of AR funding is through business lines of credit. Lines of credit are meant to provide you with working capital to use to fulfill the sale made with the AR.

Each month you’ll provide an AR aging report with exclusions for late pays, concentrations, government accounts, and accounts canceled out by an account payable. You can then borrow up to somewhere between 50%-80% of that balance, depending on your credit profile and the lender.

The other two AR financing options are almost always used by companies that are down on their luck. If you’re looking for a good line of credit, you’ll have to be in a pretty good spot with your business. If you aren’t, ask your banker about utilizing the Small Business Administration (SBA) to do it.

3 pros of accounts receivable financing

There are always upsides to getting more cash now.

Speed up cash conversion

A big piece of your business plan going into a new business — and managing working capital once you’re up and running — is figuring out how you’ll speed up your cash conversion.

The longer it takes to get paid after you’ve had to shell out cash for materials and labor, the slower your company will grow. The more quickly you can convert sales to cash, the faster you’ll be able to invest that cash into new projects.

Keep it off your balance sheet

If you get a line of credit and draw on it, you’ll have to add the balance to your liabilities. But if you factor your AR, the journal entry is to debit cash and credit receivables. The liabilities section is not affected.

This is helpful when you’re looking for a term loan because your debt service will look better without other debt payments due on the balance sheet.

Available only when needed

Some financing sources require an annual fee, often as much as 1%, to be paid for the privilege of using them. AR financing is convenient where it is available when you need it, but you only have to pay for it if you use it. This makes it easier to strategize and not use it unless it’s absolutely necessary.

3 cons of accounts receivable financing

Here are a few reasons to think twice before using AR financing.

You have to rely on credit sales

The first downside is more about using AR in general. Selling things on credit may be necessary, especially if you’re selling to big businesses, but the more you can do cash sales, the better. It will speed up your cash conversion, and you won’t have to worry about deadbeat customers not paying.

You’ll have to pay more

As I mentioned earlier, the more specialized the financing source, the more expensive it is. While a normal bank loan likely wouldn’t have an interest rate of more than 8% right now, AR financing can cost up to 20% with all fees included.

If you can make it work in a costly way, it can be effective, but don’t put yourself that far behind the ball if you don’t have to.

You can get behind

There’s a way to create a little Ponzi scheme within your own business if you get addicted to AR financing. You take a big order and finance the production, but you can only finance 75% of the sale amount, so you make two more sales so that you can cover the production and more. But now you have to be able to finance those sales, so you can go crazy discounting to make more sales to finance the other sales.

If the cost of financing is more than your gross margin on the sale, or if you don’t have the cash to bridge the gap between financing and material cost, you could fall into this trap. Sometimes it’s better for your business over the long term to slow down.

What do you call it when you get a loan from a pirate?

ARRRR financing.

All financing decisions should be made with two questions in mind: What is the cost relative to the money you can make with the funds, and what are the limits the financing puts on your business? AR financing can have pretty high costs, but it can be helpful as long as it doesn’t limit your business decision-making.