Very simply, an account receivable (AR) is money owed to a company by a customer who has purchased goods or services on credit. Very rarely in business are goods and services paid for on delivery. Instead, they are usually sold on credit.
If a manufacturer supplies a customer with a truckload of goods on 1 June and gives the customer 30 days credit, for that period the company will have an account receivable. This is can also be called a trade receivable.
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What are Accounts Receivable in Accounting?
Classified as a current asset for accounting purposes, an account receivable is the most liquid type of asset after cash, as, unless anything goes wrong with the collections process, the account receivable will soon become a cash payment.
There is an element of risk with every account receivable because payments may not be made on time or in full. For this reason, every business needs to be cautious when assessing a customer’s creditworthiness.
If there is some uncertainty about offering the customer credit, businesses should consider asking for payment upfront before the goods or services are delivered.
How do Accounts Receivable Loans Work?
Accounts receivable factoring unlocks the cash that is owed to a company by effectively ‘selling’ the invoice to a finance provider.
When a company makes a sale and issues an invoice to a customer, it also sends a copy of that invoice to the finance provider. The finance provider then pays an advance of that invoice at an average of 85 percent of the invoice’s value within as little as 24 hours of the invoice being issued.
Factoring is not Lending
Technically accounts receivable factoring is not lending. Instead, it is an asset purchase because the company is raising cash against its debtors.
In an accounts receivable factoring facility, the factoring provider takes over the company’s credit control process and is responsible for checking a customer’s credit worthiness and collecting payments on the company’s behalf.
Accounts receivable factoring can provide some compelling benefits for your business. Instead of being at the mercy of your customers and when, and even if, they choose to pay you, you can instead take control over your financial situation.
You can forecast your cash flow properly, take advantage of opportunities as and when they arise and pay your suppliers, rent, wages and tax bills without agonising every month. More simply, you can enjoy your profits sooner and worry less about your financial situation.
What is Accounts Receivable Factoring Good for?
Accounts receivable factoring can benefit businesses experiencing a common range of problems. That includes:
- There’s not enough to cash flow to grow
In business, the adage ‘it takes money to make money’ is 100 percent true. Factoring your accounts receivable releases the money you need to pay suppliers, take on more orders and continue to grow.
- You can’t access fast funding
If you have an unexpected expense you had not bargained for, accounts receivable factoring providers can approve new accounts in as little as 24 hours and quickly fill the gap.
- You don’t qualify for a bank loan
Factors can fund businesses with low bank balances or poor credit that wouldn’t typically qualify for other forms of finance. This is because the factoring facility is based on the quality of your customers’ credit and not your business history.
- You don’t have enough time to grow the business
Managing the credit control process and chasing payments can be extremely time consuming and takes your focus away from growing the business. Accounts receivables factoring takes care of credit control and collection for you, allowing you to focus on your most important objective.