After one of the deepest recessions in history, followed by the slowest economic recovery in history, many mid-sized businesses are finally regaining a firm foothold on their path to growth and profitability. However, it is not uncommon in this environment for a company to experience cash flow shortfalls for any number of reasons. Some companies will always experience cyclical highs and lows, which can make it more difficult to fund their growth. Others find themselves with no shortage of new business, but with insufficient cash flow to take on bigger orders or new customers. Getting off this cash flow treadmill is made more difficult by slow-paying customers who can delay receivables for weeks or months, long after production costs have been incurred by the company.Mid-sized companies facing cash flow shortages have been further challenged by the fallout of the financial crisis, which has led to banks tightening their credit requirements for business financing. Those that might be able to qualify for bank financing often find that the application and approval process is too arduous and lengthy, and the rigid terms of bank loan products are not ideal for meeting their ever-changing cash flow needs. That is why an increasing number of companies are turning to receivables financing as the preferred choice for financing their cash flow needs.

Receivables Financing Offers Ideal Solution

Falling under the broader heading of asset-based financing, receivables financing is an alternative financing solution that enables companies to use their receivables as assets that can be collateralized for immediate financing. Instead of having to wait months for their receivables to be converted to cash flow, companies can receive payment, in the form of an advance, within days.

Receivables financing is much easier for companies to qualify for because asset-based lenders rely on the quality of the collateral rather than the creditworthiness of the company. As long as a company deals with creditworthy customers and does a good job of managing its books, it is a strong candidate for receivables financing.

How Receivables Financing Works

Once a company is approved for receivables financing, a credit line or borrowing base is established by the lender, the amount of which is based on eligible receivables. The company grants the lender a security interest in its receivables as collateral. It is not uncommon for the lender to also require a personal guarantee from the company’s owners. As the business generates new receivables, they are added to the borrowing base. The borrowing base is revisited monthly by the lender and the company to update the status of the collateral. As receivables are paid, the loan balance is reduced.

The borrowing base can also be set up as a term loan with fixed terms ranging from a few months to several years. In either case, the amount that can be borrowed is based on an advance rate established by the lender, which is the maximum percentage of the borrowing base the lender will loan. The advance rate can range from as low as 50% to as much as 85% depending on the average age of the receivables and the overall creditworthiness of your customers.

Eligible Receivables
Generally, receivables that are more than 90 days old are not eligible as collateral. Receivables generated from related-third parties or customers that both buy and sell to the company are restricted, as are receivables generated from foreign customers. Receivables generated from the U.S. Federal Government are subject to the requirements of the Assignment of Claims Act of 1940.

Lockbox Payments
Typically, the asset-based lender will want to control the company’s incoming cash receipts. The lender establishes a lockbox or a blocked account at the company’s bank for the collection of receivables. Customers are instructed to mail their payments to the lockbox address where they are deposited into a segregated account.

Advantages of Receivables Financing

The advantages of receivables financing for mid-sized companies are numerous, including:
Immediate Cash Flow Relief: Advances from receivables financing can be received within a week of their request. Receivables with 30-, 60- and 90-day terms can be counted on as cash when a receivables credit line is established. Cash flow can be smoothed out as opposed to having to deal with peaks and valleys.

Instant Working Capital: Businesses will have more control over when they use a cash infusion to buy more inventory or ramp up operations when taking on new customers or bigger orders. No more lost opportunities or shying away from expansion plans due to lack of cash flow.

No Credit Qualification: The asset-based lender bases its approval almost exclusively on the creditworthiness of the borrower’s customers, so there are no credit qualifications.

No Collateral Required: A receivables financing loan secured by outstanding invoices for which the business is owed money. There is no need to risk personal or business assets as collateral.

Save Time and Resources: When receivables are turned over to a lender as collateral, they also become the responsibility of the lender for collecting payments. Receivables financing is a form of outsourcing that not only brings in money faster, it relieves the company of the time and resources it takes to collect payments.

Improved Cash Flow Management and Business Planning: When used a part of a company’s financial management, receivables financing can make cash flow more predictable, easier to manage and a more reliable for longer-range planning.

Things to Know About Receivables Financing

Loan costs: Although loan costs through receivable financing can be more expensive than traditional bank financing, they are substantially cheaper than other alternative financing, such as invoice factoring. Depending on the loan amount and the quality of receivables, the annual percentage rate on receivables financing loans can range from 7 to 15%.

Due Diligence: Before approving a loan, lenders will conduct due diligence on the collateral, checking for creditworthiness of invoiced companies. They will also review the accounting ledgers of the borrower. This could take up to two weeks and cost one to three thousand dollars.

For mid-sized companies, the biggest impediment to growth and sustainable profits are cash flow issues. Companies simply can’t afford to wait and hope their cash flow situation improves, especially when opportunities arise. Receivables financing offers companies the greatest amount of flexibility and control over financing their cash flow needs at a very reasonable cost.