Financing working capital with accounts receivables: part two

Financing working capital with accounts receivables: part two

In the first part of this two-part series on financing working capital using accounts receivables, we discussed two of the main ways to carry out this type of financing—factoring and reverse factoring. For the second phase of this introduction, we will explain asset-based lending and selective accounts receivables financing.

Asset-based Lending

Unlike factoring, asset-based lending uses receivables as secured assets for collateral for a loan or line of credit. Since this arrangement operates using secured assets, interest rates are lower than arrangements using unsecured assets because lending entities can recoup loans by taking hold of the receivables. Asset-based loans often operate as revolving credit lines, which provides companies continuous working capital based on their receivables so they can, for example, meet payroll or increase inventory. It is also available from a number of entities, including banks and independent finance companies. Like with factoring, working capital in asset-based lending can be quickly acquired, factored receivables are noted on balance sheets as debt, and the option is more expensive than traditional loans.

In asset-based lending, companies or suppliers often leverage all of their receivables to the lending company, receiving an advance based on a percentage of its secured assets, which is usually between 70-80%. Interest rates on these loans range from 7-17%, and banks can also require thorough due diligence and audit fees, with larger banks potentially requiring mechanisms like personal guarantees and taking over a company’s other banking relationships for loans. This generally gives lenders more control over a company’s cash flow.

Asset-based lending, contrasting factoring, is less suitable for small companies because lending bodies prefer loaning large sums of money. The logic behind this is that it takes the same amount of effort to monitor a large loan as a small one. Thus, this type of financing for working capital is beneficial to those that have highly leveraged balance sheets, and can be useful for financing operations like acquisitions.  Particularly, manufacturers, distributors, and services companies with these highly leveraged balance sheets who have seasonal needs and industrial cycles that impinge upon cash flow are ripe for asset-based finance.

Selective Accounts Receivables Financing

Selective accounts receivable has advantages over factoring and asset-based lending because it allows funds to be delivered more efficiently and at lower cost and reduced risk. It accomplishes this goal because companies can choose which receivables they want financed and when they want to take advantage of the facility, receivables are not recorded as debt, companies can avail themselves of multiple funding sources, and by fostering better pricing. The rates for financing this option are also usually lower than other options.

In this financing method, companies can choose which receivables they want financed for early payment, giving them more control over cash flow. Moreover, since companies can use this facility when they need it, it can be a boon for companies that have seasonal needs or are operating in volatile economic times. Selective accounts receivables are also not counted as debt on balance sheets. This means that they do not influence debt ratios or other credit lines.

In opposition to factoring and asset-based lending, when companies use this method they can take advantage of multiple funding sources to free up working capital. Being able to integrate multiple lenders into a push for additional funding is advantageous because it lowers the risk present in using a sole source for funding. Additionally, the multiple funding sources enhance price competition.

Conclusion

Funding working capital using accounts receivables is a good way for businesses to generate funds, particularly those in need of quick capital and also for SMEs. Regarding SMEs, traditional factoring and selective accounts receivables financing form effective methods for financing, and for larger enterprises, such as buyers, reverse factoring and asset-based lending are additional available options for creating working capital using accounts receivables.