How to Bridge the Accounts Receivable Gap

How to Bridge the Accounts Receivable Gap

How to Bridge the Accounts Receivable Gap

This is part two of a two-part series on accounts receivable financing. 

Robert Herjavec said that “cash is the lifeblood of your business.” If cash supplies the life flow to a business, then accounts receivable factoring can be a sort of paramedic that saves a business during times of “blood clot,” when there’s a cash flow crunch.

In a prior article, I covered the ways the 29 million small businesses in America that experience times of cash flow crunch deal with it by offering trade credit financing programs to their clientele. Most of these industry types include manufacturers, trucking, staffing, janitorial, security companies, printers and various contractors.

Trade credit, or Net D, is established when a business allows its customers 10 to 90 days to pay in full for products and services already rendered. The outstanding invoices become “accounts receivable” for the business, and are placed on the balance sheets as a business asset. However, while some businesses are well capitalized to handle the up-to-90-day payment collection process, some are not, and end up with cash flow issues when cash outflows are stacking up and cash inflows are at a standstill.

This is where accounts receivable factoring comes into play. However, accounts receivable factoring isn’t the only method to address these emergency blood clots. Here are some other options to deal with a cash flow crunch so your business doesn’t die an untimely death.

Accounts Receivable Financing

If a merchant chooses to deal with a cash flow crunch using accounts receivable financing, they do not sell their receivables. Instead, they leave outstanding receivables on the balance sheet and use the asset as collateral for a loan transaction.

The approval amount is usually 60% to 80% of the value of the outstanding receivables. Accounts receivable financing is known as an asset-based lending program, which takes an asset of value that’s already pre-owned, and uses it as security or collateral for a loan transaction. Other than accounts receivables, the types of assets that are usually pledged for asset-based lending programs include, but are not limited to:

• Commercial equipment

• Inventory

• Real estate

• Luxury cars

• Commodities

• Collectibles, antiques and artwork

• Jewelry

Purchase Order Financing

Before an accounts receivable is created, the merchant has to buy the materials needed in order to render the services or products in question. Sometimes a merchant has a cash flow crunch upfront, and doesn’t have the capital to purchase the necessary materials. This is when another aspect of factoring can be used: purchase order financing.

With purchase order financing, a lender advances capital to the merchant’s material supplier or vendor so the merchant can obtain the materials they need to fulfill a client’s outstanding purchase order. Once the materials are received, the product or service is rendered and payment is collected from the merchant’s customer. Then the lender is repaid from a portion of the revenue, plus a discount fee for service.

The advance amount usually covers the cost of the entire material purchase, or at least 80% of the amount. The lending firm could also decide to open up a vendor line of credit for the merchant, which would allow the merchant to obtain goods and materials from a particular vendor on an ongoing basis.

Merchant Cash Advance

Sometimes even after using any or all of the above options, a merchant might still have a cash flow crunch. In this case, they can call upon another resource—the factoring of credit card receivables, otherwise known as a merchant cash advance (MCA).

With the MCA, there’s a buyer (the MCA firm) and a seller (the merchant). The MCA firm looks at the merchant’s previous credit card processing statements and notes that the business has been doing $60,000 a month in Visa and MasterCard volume over the previous 12 months. Based on those numbers, the MCA firm offers to buy $72,000 of the merchant’s credit card processing receivables in exchange for advancing them $60,000. Then the MCA firm keeps 15% of the merchant’s daily Visa and MasterCard batches going forward until it collects the full $72,000.

As long as the merchant continues to process $60,000 a month in Visa and MasterCard volume, the MCA firm should collect the full $72,000 in about eight months.

Short-Term Alternative Business Loan

A merchant can also use a short-term alternative business loan to help with additional cash flow crunches that persist after using accounts receivable factoring, accounts receivable financing and purchase order financing. This product, while similar to the MCA, is an actual loan transaction and not a purchase—or factor—of receivables.

The lending company will note that a merchant is doing $60,000 a month in revenue and might decide to offer a short-term alternative business loan of $60,000, with a $72,000 total payback, on an eight-month term with a weekly fixed payment of $2,250. There will be an origination fee, disbursement amount, fixed payments and fixed terms—all of which are associated with the aspects of a true business loan.

On-time payments are reported to various business credit bureaus, which provides positive business credit tradelines for the merchants that utilize the short-term alternative loan product.

Trade Credit Insurance

If your accounts receivables are still sitting on your balance sheet and you haven’t yet decided to factor or finance them, and are planning on waiting out the timeframe of the customer’s payment schedule, you have an option for additional protection: trade credit insurance. This is basically a side commercial insurance policy that covers losses related to customers who do not fulfill their entire payment obligation within the 10 to 90 days specified on the invoice.

Adding trade credit insurance also strengthens the quality of your receivables, which might or might not be a requirement for closing an accounts receivable financing deal. The policy would also provide you more leverage to negotiate better terms with clients. This gives you a competitive advantage and allows you to sign on clients that might have higher-risk profiles.

Keeping Your Business Alive

For a significant percentage of the 29 million businesses in the United States, the fundamentals of their business model might in fact be strong when it comes to creating revenues, competently managing expenses and being able to generate a good profit margin—but the culprit might be a slow-paying customer base.

Inefficient cash flow management is one of the main reasons for early small business failure. However, with the emergency help of accounts receivable factoring and its sister products, the blood of your business can continue to flow and you can avoid the blood clots that might otherwise spell the early demise of your American dream.

This article was originally written on August 8, 2016 and updated on February 1, 2021.

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