What is accounts receivable (AR) financing?

Accounts receivable (AR) is the balance of outstanding money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivable are listed on the balance sheet as an asset, as it’s essentially money that is owed to the company.

Accounts receivable finance, then, refers to a type of financing that’s based on borrowing money based on the value of the accounts receivable. You can think of it as a line of credit that’s backed by outstanding debt that is due to be received from customers or clients. AR financing allows for the use of capital that would otherwise be unusable until the debtor settles their invoice, providing more working capital to utilise.

Most companies operate by allowing a portion of their sales to be on credit. Businesses sometimes offer credit to frequent customers that receive periodic invoices, enabling them to avoid making manual payments for each transaction. In other cases, companies routinely provide all of their clients the ability to pay after receiving the service.

AR finance example

Consider a water company that bills its clients after the clients receive their water. The water company’s accounts receivable department records the money owed for unpaid invoices as an asset on the balance sheet as it waits for customers to pay.

If that same water company needed a working capital boost, AR finance would enable them to borrow money against the value of their accounts receivable (or, more likely, against a portion of their accounts receivable). This would allow them to start to use the money they know they will be receiving when outstanding invoices are settled, when they can then settle their accounts receivable agreement.

Benefits of AR finance

Accounts receivable finance is a fundamental part of many companies’ working capital management strategy. These are the key benefits for businesses that employ AR finance:

Quicker cash flow

The main and most obvious benefit of AR financing is that it facilitates fast cash flow. Instead of having to wait for invoices to be paid for working capital to be freed up – with AR finance you can make full use of all of your assets (current and owed) whenever you want. This can be a game-changer for high-growth businesses with short cash runways, helping them to make the best use of their assets.

Fewer distractions

Outside of actually quickening cash flow, AR finance also takes the pressure off needing to chase invoices for prompt payment. Since you can borrow money that would otherwise be tied up in unpaid invoices with an AR finance agreement, it’s less urgent for you to aggressively pursue debtors. That means you can focus more on maximising the use of your working capital.

Cheaper than alternatives

AR finance is generally user-friendly compared to alternative working capital management methods. Most importantly, it’s quicker, cheaper, and less limiting than a bank loan.

Why are accounts receivable considered current assets?

A company has receivables if it has made a sale on credit but has yet to collect the purchaser’s money – it’s essentially a short-term IOU agreement.

Businesses record AR as assets on their balance sheets because the customer is legally obliged to pay the debt. Further, as accounts receivable are current assets, they are due from the debtor in one year or less.

Accounts Receivables vs Accounts Payable

When a company owes debts to its suppliers or other parties, these are accounts payable. Accounts payable is the opposite of accounts receivable – any business-to-business credit agreement creates AP and AR. To illustrate this, consider the following example:

Company A cleans Company B’s window and bills them for the service.

Company B now owes them money, so it records the invoice value in its accounts payable.

Company A is waiting to receive the money, so it records the invoice value in its accounts receivable.

AR finance as part of a wider working capital strategy

AR finance is just another string in your working capital bow, and often works best as part of a wider working capital management strategy alongside dynamic discounting and other supply chain finance solutions. How you utilise your accounts receivable depends on the objectives of your business.