It is important for businesses with urgent, short-term cash flow needs to have quick, convenient, and flexible access to working capital.
In many scenarios, the best way for companies to get cash is to secure funding with business assets, such as unpaid invoices, inventory, or real estate. Two common avenues businesses pursue to procure working capital are Accounts Receivable Finance, with providers such as Raistone, versus Asset-Based Lending.
For most small- and medium-sized businesses (SMBs), Accounts Receivable Finance will prove to be a better option than Asset-Based Lending for a variety of reasons, including speed of funding, cost, credit rating, flexibility and more. Let’s dive deeper into the differences between these two types of financial products and the advantages of each solution.
What is Accounts Receivable Finance and how does it work?
Accounts Receivable Finance (ARF) is an arrangement that allows companies to sell their outstanding accounts receivables or customer invoices at a marginal discount to secure immediate access to working capital. It is also referred to as non-recourse factoring, alternative financing, or invoice financing, but the key thing to remember is that ARF can add more working capital or liquidity to a business. Since ARF is not typically considered a loan, like you would get from traditional bank financing, it means that there is no debt incurred on the balance sheet – an important consideration for small businesses and large corporations.
Generally, the process of ARF is as follows: companies submit their unpaid invoices to a financing or factoring company, which then assesses the quality of these invoices and the creditworthiness of the companies that owe these accounts receivables. Then, the financing company purchases the invoices — and the right to receive future payment on them — resulting in the trading company receiving an early payment of that invoice almost immediately, less a marginal percentage. When the invoice payment is owed on the original due date, the trade company’s customer pays the full amount on the invoice to the financing company. This form of financing allows the trade company to essentially sell its accounts receivable, which can also give the trading company a revolving line of credit that can be used by business owners when they need it.
What is Asset-Based Lending (also referred to as an Asset-Based Loan), and how does it work?
Asset-Based Lending (ABL) is a type of loan or line of credit secured by a company’s assets — such as inventory, equipment, invoices, or real estate — as collateral. The value of these assets usually determines the loan amount, and this type of lending is often used by companies that require flexible working capital to manage cash flow or fund growth initiatives. Since unpaid customer invoices can securitize ABL, it often gets mistaken and confused with ARF.
Regarding ABL, lenders determine a borrowing base by evaluating the value of the assets being used to secure the loan and then offer a loan amount, or a line of credit, based on a percentage of their worth. Businesses can then draw on the approved credit facility for immediate working capital, while lenders periodically reassess the asset values to ensure they remain sufficient for the loan. The lender can seize the assets if the business defaults to recover their funds. This financing option depends on the value of your company’s assets and having the collateral to secure the loan.
With ABL, advanced rates and interest terms can vary tremendously depending on the assets being used to secure the loan.
What are the benefits of using ARF?
There are several benefits to securing working capital via ARF. Some of the benefits include, but are not limited to:
Quicker access to cash: ARF can provide immediate cash flow by leveraging unpaid invoices, allowing businesses to quickly address working capital needs. Since it’s not a loan from a traditional financial institution, it can be easier to obtain.
A quicker and simpler approval process: Approval is often quicker than traditional bank loans or asset-based lending because it hinges primarily on the quality of the receivables and the purchasing of an asset.
Doesn’t require years of historical revenue data: The quality of the receivables is based upon the creditworthiness of the buyer as opposed to the supplier, meaning the credit rating of the trade company is not a consideration. Even if your company is less than a year old with very little revenue or credit history, you can still obtain working capital if your customers are upstanding companies that consistently pay their full invoices on time. There is less risk associated with this process.
Non-debt option: Non-recourse ARF allows companies to procure working capital without taking on any debt.
Selective invoicing: Some ARF methods enable businesses to finance only certain invoices, giving them flexibility over which transactions to involve.
Who it’s for: ARF is a good option for companies with high Days Sales Outstanding or unusual/unexpected cash outlay who don’t want to take on debt.
What are the benefits of using ABL?
There are several benefits to securing working capital via ABL. Some of the benefits include, but are not limited to:
Operational flexibility: Companies maintain control over their operations and assets without having to disclose invoice details to third parties, though sometimes they do.
Multi-asset leverage: By being able to use different asset types (inventory, equipment, real estate), companies can diversify their collateral and maximize credit availability.
Doesn’t require cash flow: The loan, or line of credit, is based upon the quality of the collateral (assets) as opposed to the stability of your cash flow.
Who it’s for: ABL is good for companies seeking flexible financing to support cash flow needs or fund business growth. These companies are interested in using assets such as unpaid invoices to secure working capital and have additional assets such as inventory, equipment, or real estate.
Comparing Accounts Receivable Financing Vs. Asset-Based Lending to Improve Cash Flow and Access to Working Capital
| Category | Advantage | Explanation |
|---|---|---|
| Speed of Funding | ARF | ARF typically provides faster access to cash due to its simplified approval process. |
| Credit Limit | ABL | ABL might be able to provide a higher credit limit just by virtue of leveraging multiple asset types. However, this will just depend on the worth of the company’s assets. |
| Advance Rate | ARF | ARF will usually provide a higher advanced rate since accounts receivables are liquid assets that can be converted to cash more easily than inventory, equipment, or real estate. |
| Approval Criteria | ARF | ARF approval relies primarily on the quality of receivables, as opposed to the valuation of multiple assets, making it easier to obtain. |
| Collateral Requirements | ARF | ARF only requires unpaid invoices, making it ideal for asset-light businesses. |
| Control Over Assets | Even | ABL lets businesses retain control over assets since they aren’t sold to lenders. |
| Flexibility | ARF | ARF allows selective financing of specific invoices, providing flexibility in funding. |
Why ARF is a better option than ABL and Asset-Based Financing?
ARF can be advantageous over ABL for most SMBs because it often provides quicker access to cash by leveraging specific unpaid invoices. ARF’s simpler approval process focuses on the quality of these invoices rather than requiring an extensive asset valuation. This allows businesses to obtain funding more rapidly and selectively, choosing which invoices to finance while maintaining control over their other assets.
Additionally, ARF only requires tangible collateral beyond the invoices, making it suitable for businesses lacking significant physical assets. Ultimately, its speed and flexibility can be ideal for companies needing immediate working capital.
Improve your cash flow with Accounts Receivable Financing from Raistone
Since its founding, Raistone has provided working capital for businesses across the U.S., helping them improve their financial statements, keep debt off each company’s balance sheet, and manage their cash flow. At a time when many corporations are taking as much as 90 days or more to pay their invoices, Raistone offers ARF options to help companies maintain their current business and grow.
About the author
Alexa Koppenal serves as an Assistant Vice President on the Originations team at Raistone. She onboards and manages Raistone clients, enabling them to improve their cashflow and grow their business with unique non-debt financing opportunities. Prior to joining Raistone, Alexa was at ING where she worked on the Corporate Sector Coverage team. She holds a Bachelor of Arts in Finance from Mercy University.
Frequently asked questions about ARF and ABL
What is the difference between Accounts Receivable Finance and Asset-Based Lending?
Accounts Receivable Finance, or factoring, involves a business selling its accounts receivable to a factor at a discount. Asset-Based Lending, on the other hand, uses a business’s assets, such as accounts receivable and inventory, as collateral for a line of credit.
How are invoice financing (i.e. factoring) and asset-based lending different?
Factoring involves the sale of accounts receivable to a third party, while asset-based lending uses assets like accounts receivable and inventory as collateral for a loan.
What types of asset-based loans can a business obtain?
Who typically acts as the lender in asset-based lending?
How does factoring and asset-based lending allow businesses to borrow money?
In what ways can assets be used as collateral for a loan in asset-based lending?
In asset-based lending, assets such as accounts receivable, inventory, machinery, and real estate can be used as collateral for loans, giving businesses flexibility in accessing financing.
