In today’s diversified financing climate, more businesses are turning to alternative sources for working capital. One popular choice is signing up for an account receivable loan, a convenient and affordable way to turn accounts receivable into cash quickly and easily. Sometimes called a “factoring loan,” an accounts receivable loan lets the business owner receive a substantial advance on outstanding invoices. The result: expedited cash flow without debt.
Why are both long-lived as well as startup businesses choosing account receivable loans for their working capital? Let’s look at how loans work in the world of banking. Banks lend money to businesses with strong credit scores and established payment histories. Loan officers and underwriting committees closely evaluate each loan applicant’s history to better ensure that the bank will be repaid. In addition they require borrowers to post collateral to guarantee the loan. If the borrower defaults on repaying the bank loan, the bank can take that property pledged as collateral and sell it to lessen its losses for a bad debt.
However, many companies have had financial challenges and have less-than-perfect credit scores. Startup companies lack a long track record for on-time payment of bills and can have difficulty qualifying for a bank loan. In addition many businesses lack those “hard assets” that banks favor as collateral for a loan. A “hard asset” could be real estate, buildings, machinery, inventory, or other tangible things of value to the lender as collateral (security). Banks have become increasingly restrictive in their lending practices and many businesses simply do not qualify for loans and lines of credit.
Fortunately, accounts receivable loans can open the door to better cash flow, improved credit scores, and funds for expansion, regardless of your past payment history or your possessions. Factoring loans bring you the working capital you need to pay bills, cover payroll, purchase equipment without incurring debt.
In addition, factoring company financial professionals do not penalize potential clients based on their credit scores or limited payment history. Factoring professionals evaluate applicants based on the reliability and credit history of their customers. That’s why the receivables loan is fast becoming an appealing funding choice for many small and medium-sized companies.
Accounts receivable loans: No hard assets needed
Banks like to lend against “hard assets” as it offers them security in the event borrowers become unable to repay the debt. The bank can recover its loss and sell the assets given as collateral to recoup its loss on the loan.
It is possible you could be giving up too much collateral to the bank and risking the loss of too much property if you can’t repay the loan. Don’t assume that because you are borrowing money to buy a truck, the bank will not obtain a security interest in your accounts receivable or your inventory. Ask up front what the collateral requirements are and don’t pledge any more collateral than is necessary.
While an over-collateralized loan may be beneficial to the bank, it could be detrimental to your business. It places the bank in control of your business and makes it quite difficult (sometimes impossible) to convert the equity that has built on your assets into cash to further expand your business, make payroll, purchase additional inventory, and take on larger accounts. Sometimes the only relief is to pay off the bank with money sourced elsewhere to obtain a release.
On the other hand, accounts receivable loans – or factoring loans – do not require hard assets and do not risk your collateral. Instead of pledging real estate or possessions to repay a loan out of unknown future income, you are simply receiving an advance on payments from customers on work that you have completed. You gain the convenience of upfront payment on what you are already owed – not what you might earn in the future.
By factoring your accounts receivable with a top-tier factoring company, you speed up your cash flow and get paid immediately. When you don’t wait 30, 60 or even 90 days for your customers to pay their bills, you gain a cushion of ready cash to begin to grow your business. Whether you want to buy more equipment for your trucking company, hire more staff for your cleaning business, build inventory for your wholesale business, or start a new line of products at your factory, you can plan for the future – all without borrowing and creating additional debt. An accounts receivable loan can make a big difference in your operations right away.
Difference between factoring vs. accounts receivable financing
It may not be obvious to the novice business owner why it is important to be careful with the assets that are offered as collateral. By giving a bank too much collateral, you lose the mobility to sell the underlying assets or refinance them elsewhere to generate emergency cash. You must have the bank’s permission before you sell or you may be guilty of conversion (a legal term referring to improperly disposing of assets that are subject to a lien). Furthermore, if you do want to sell any assets that the bank holds as collateral, you are obliged to settle the loan with the proceeds of the sale.
Emergency cash isn’t only needed when times are bad – you may need to expand your business or take advantage of a once-in-a-life-time opportunity. While it may be possible to persuade your bank to release part of the collateral it holds when the economy is on an upswing, doing so in tough times is very challenging.
Let’s examine an entirely different twist: if you are in the services industry, perhaps a temporary staffing firm, a nurse staffing firm, or an IT staffing firm, it is highly likely that you won’t have the same “hard” assets that would belong to a manufacturer or trucking company. Let’s say that your business is in good standing and expanding rapidly. Therefore, you need expansion capital to hire more people or to finance accounts receivable. When you approach the bank for a loan, you will find that loan officers are reluctant, despite what they may say publicly, to lend money to companies without tangible, hard assets. Unfortunately, service businesses’ largest asset is their accounts receivable, and they may, therefore, face a bigger challenge to obtain a conventional bank loan.
Will banks lend against accounts receivable?
Certainly, if you qualify.
Will they lend you anywhere near their value?
How do you know if you qualify?
You will likely have to wait for weeks or months while the banker spends hours over reams of paperwork he or she required you to furnish. Then you’ll have to wait for the loan committee to meet. Chances are they will ask for more collateral, more restrictive terms, a higher interest rate, or more information. Your banker will continue this due diligence until the approval is granted or denied by the loan committee.
Tedious to say the least!
So, let’s examine the pitfalls we were discussing earlier. Let’s say business is good and you go to your bank and qualify for an SBA-guaranteed or non-SBA-guaranteed line of credit secured by your accounts receivable. Perhaps you have $100,000 of accounts receivable and the bank “generously” offers you a $50,000 revolving line of credit secured by a blanket lien on all your assets.
Six months later, business starts to take off. Monthly sales are increasing 10% per month and now you have $160,000 in accounts receivable. However, all your cash is tied up in the hands of your customers and you are having a tough time making payroll. Moreover, a large, new, profitable order just came in and you’re afraid to take it because it would mean having to hire another employee – and you already face the challenge of having to pay the current employees.
You jump in your car, go down to the bank and say: “How about an increase in my line of credit to $100,000 to help me expand my business?” If accounts receivable is your business’s primary asset, don’t expect your banker to be thrilled to lend money against it, much less increase the amount already committed. Remember, accounts receivable is not a tangible, hard asset, thus your banker’s reluctance to lend against them.
Here’s where the real predicament lies: you have an asset that is currently worth $160,000, but six months ago you borrowed $50,000 against it. If the bank is unwilling to lend any more money against this asset (accounts receivable), you must consider your options to alleviate the lack of working capital, limiting business expansion. This is the time to consider factoring your accounts receivable.
What does it mean to factor accounts receivable?
A good factoring company will be able to analyze your accounts in 24 hours or less and determine whether you are eligible to factor. If you qualify, the factoring company will make a lump sum advance to you against your entire book of accounts receivable, segregating the amount needed to pay off the bank to secure a release of the collateral. It is quite possible that by taking the factoring route, the borrower can generate 50% to 100% more cash than would have been possible when following the conventional term-loan route.
How a good factoring company can provide you fast working capital
To generate the most working capital, consider factoring accounts receivable rather than borrowing against them. Not only is factoring fast, flexible, and more affordable than you’d expect, but as your accounts receivable grow, so does the amount of cash available to your company. In factoring, there are no loan committees, regulators, government bureaucrats or auditors determining your fate; there is no confrontation with a banker when you need additional funds. Access to cash is fast and based only on the quality of your customer’s credit – not yours.
Your accounts receivable factoring arrangement gets you paid fast without debt – a clear advantage for many companies, whatever their size or growth stage.
For more information about accounts receivable loans with Interstate Capital, get started today with a free consultation.