Education Library · Financing Tools · Article 5
Accounts receivable financing and invoice factoring get used interchangeably by sales reps and plenty of websites. Both turn unpaid invoices into cash sooner, but they work differently, and the difference affects your customers, your costs and who handles collections.
What AR financing is
Accounts receivable, or AR, is the money customers owe you for work you’ve already done and billed. AR financing uses those receivables as collateral for a loan or line of credit. With factoring you sell your invoices. With AR financing you keep them and borrow against them, the same way you’d borrow against a building or a piece of equipment.
How it usually works
Most AR financing is set up as a revolving line of credit. The lender reviews your receivables and decides which ones qualify. You can borrow up to a percentage of those qualifying receivables, often 70% to 90%, and that available amount is called your borrowing base. Your customers keep paying you the way they always have. As they pay, you pay down the line, and as you send new invoices the borrowing base grows again. When the business is busy and billing heavily, there’s more available. When things slow down, the line shrinks with it.
Because you’re still collecting from your own customers, AR financing is usually invisible to them. For trades businesses working with general contractors, property managers or other commercial customers, that’s often worth a lot.
How it compares to factoring
| AR financing | Invoice factoring | |
|---|---|---|
| What happens to the invoice | You keep it and borrow against it | You sell it to the factor |
| Who collects from your customer | You do | The factor does |
| Does your customer know | Usually not | Usually yes |
| How it shows up | Debt on your balance sheet | A sale of an asset |
| What approval leans on | Your business and your receivables | Mostly your customers’ credit |
| Typical cost | Usually lower | Usually higher |
What lenders look at
Because you’re the one collecting and repaying, AR lenders look harder at your business than a factor would. Expect them to want your AR aging report, which lists every open invoice and how long it’s been outstanding. Invoices older than 90 days usually don’t count toward the borrowing base. If one customer makes up most of your receivables, the lender may limit how much of that customer’s balance counts. They’ll also want a current profit and loss statement, balance sheet and tax returns, and they’ll look at whether your bookkeeping is current and your aging report matches your bank activity. Banks tend to be the strictest. Specialty lenders are more flexible and charge more.
Most lenders also require regular reporting after the line is open, sometimes monthly and sometimes weekly, with updated aging reports and a borrowing base certificate showing what you can draw. Some do periodic audits of your receivables. If your books are current that’s manageable. If your bookkeeping runs three months behind, it’s a real burden.
Liens and who’s first in line
The lender will file a UCC lien on your receivables, and sometimes on all business assets, and it needs to be in first position on those receivables. If an existing SBA loan, bank loan or MCA already has a blanket lien on everything the business owns, an AR deal gets difficult until that’s sorted out.
An electrical contractor we work with has averaged $250,000 to $350,000 in receivables over the past year, against payroll of roughly $20,000 to $25,000 a week. Five to ten percent of each project is held back as retainage, and it comes in slowly. On paper that’s a strong borrowing base. When he approached his bank about a line of credit, the bank never got as far as the receivables. It pulled the credit report and found a pile of UCC filings, including old ones left by the previous owner that were never terminated, and it saw it would be second in line behind an existing SBA loan. Its answer was to clean that up first and then talk.
What else can go wrong
Slow-paying customers shrink your line. As invoices age past the lender’s cutoff they fall out of the borrowing base, so available credit drops right when you might need it most. If a customer never pays, you still owe the lender. The agreement may restrict other borrowing, and there may be fees beyond the rate, like unused line fees, monitoring fees and audit fees.
Where AR financing fits in the trades
Like factoring, AR financing depends on invoices owed by businesses or government agencies. A residential service company paid by homeowners at the time of service usually won’t have the kind of receivables these lenders want. It fits best for trades businesses with steady commercial work, predictable billing, a spread of customers who pay on time, and bookkeeping that’s kept current. Construction receivables can qualify, but retainage and progress billing often reduce how much a lender will count.
For many established businesses, AR financing is the next step after factoring. It usually costs less, you keep control of your customer relationships, and it’s a real line of credit with a lender rather than a string of invoice sales.
This article is educational and isn’t legal, tax, accounting or lending advice. Program rules, lender terms and credit bureau practices change, so verify current terms before acting.
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