Keeping the Cash Flowing

June 11, 2024   |   Written By Lexicon Bank
Keeping the Cash Flowing

Running a business requires a steady cash flow, but what happens when customer payments lag? This is where accounts receivable (AR) lines of credit can become helpful. They act as financial lifelines and allow businesses to access capital based on outstanding invoices that have yet to be paid.

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What Is an Accounts Receivable Line of Credit?

An accounts receivable line of credit, or invoice financing, is a loan secured by money owed to your company in the form of unpaid invoices. Think of it like a credit card against outstanding customer bills. From a lender, you borrow a percentage (usually 70-80%) of the value of outstanding invoices. The lender provides immediate cash while you await customers who have yet to settle their account payments. Once the customer pays the invoice, you repay the lender the borrowed amount plus any associated interest and fees.

Ideal Situations for Using AR Lines of Credit

AR lines of credit are particularly beneficial in several business scenarios:
  • Rapid Growth
Companies experiencing rapid growth often face temporary cash flow squeezes while waiting for customer payments. An AR line of credit bridges these gaps and allows them to maintain operations and to continue to capitalize on new opportunities.
  • Seasonal Businesses
Businesses with seasonal sales fluctuations utilize AR lines of credit to smoothen out valleys in their cash flow. During peak sales periods, they can access funds to cover expenses and repay loans acquired during slower times.
  • Long Payment Terms
If your business offers customers terms with extended payments (e.g., 30-60 days), AR lines of credit help bridge the gaps between issuing invoices and receiving payments.
  • Building Inventory
Need to stock up on inventory for an upcoming sales season? An AR line of credit allows you to access cash to purchase inventory without waiting for existing invoices to be paid.  

Applying for an AR Line of Credit

The application process for an AR line of credit is generally simpler than obtaining traditional bank loans. Here's a basic outline:
  • Gather Documentation
Prepare financial statements, past-due invoices, and business plans to demonstrate your company's financial health and creditworthiness.
  • Shop Around
Compare rates and terms that different lenders offer. Factors like your industry sector’s health, credit history, and average invoice size will influence the interest rates and fees associated with lines of credit.
  • Submit an Application
Once you've chosen a lender, complete their application and submit the required documentation.
  • Approval Process
The lender will assess your business and creditworthiness and decide. This process typically takes 1-2 weeks.  

Advantages of AR Lines of Credit

  • Expedited Cash Flow
Provides immediate access to cash to cover expenses and maintain operations while waiting for customer payments.
  • Flexible Funding
The line of credit allows you to borrow only what you need up to the pre-approved limit.
  • Scalable Solution
The line of credit can grow with your business, allowing you to access more funding as your invoice volume increases.  

Disadvantages of AR Lines of Credit

  • Higher Cost
AR lines of credit typically carry higher interest rates than traditional loans. Fees associated with origination, maintenance, and collections can add to the overall cost.
  • Debt Dependence
Over Reliance on an AR line of credit can create a cycle of debt if customer payments are consistently slow or default.
  • Collateral Requirements
While not always necessary, some lenders might require additional collateral beyond the invoices.
  • Customer Dependence
The creditworthiness of your customers ultimately impacts your ability to repay the loan.  

Alternatives to AR Lines of Credit

  • Small Business Loans
Traditional bank loans can offer lower interest rates but may be harder to qualify for, especially for startup businesses.
  • Invoice Factoring
With invoice factoring, you sell your invoices to a factoring company at a discount in exchange for immediate cash. Factoring offers faster access to funds but is more expensive than AR lines of credit.
  • Merchant Cash Advance
This option provides a lump sum of cash upfront based on your future sales receipts. However, merchant cash advances are quite expensive due to higher fees and interest.  

The Takeaway

Accounts receivable lines of credit can be valuable tools for businesses facing temporary cash flow challenges. However, it's crucial to weigh the advantages and disadvantages and to consider alternative financing options before making a final decision. Carefully analyze your specific needs, compare loan terms, and ensure you understand the associated costs before utilizing an AR line of credit. Consulting with a financial advisor or your personal Lexicon Banker is highly advisable.

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