Maximizing the Benefits of Trade Credit with Accounts Receivable Financing
Content
Fact-checked by: Bruce Sayer
Trade credit is a common financing arrangement in business-to-business (B2B) transactions where a supplier allows a buyer to purchase goods or services on credit, with payment deferred to a later date. Typically, suppliers offer specific credit terms such as 30, 60, or 90 days for payment. Usually, trade credit comes with an interest-free period, enabling buyers to pay without incurring additional charges if they settle within the agreed timeframe. This arrangement helps businesses manage cash flow by allowing them to sell their goods or services before making payments.
However, trade credit also involves a certain degree of risk for the supplier, as they extend credit to the buyer, who may delay or default on payment. Suppliers typically assess the buyer’s creditworthiness to mitigate this risk, and often arrange a financial arrangement to ensure reliable cash flow.
Leading specialty lenders provide a selection of cash flow solutions to convert the value of invoice receivables into immediate cash in hand. Accounts receivable financing is a category of flexible cash flow solutions used to optimize liquidity and mitigate the risks associated with delayed or default payments.
This article explores these flexible cash flow solutions provided by leading specialty lenders, how they work, and their ability to maximize the benefits of trade credit.
Is trade credit worth the risk?
While trade credit helps to elevate a supplier’s competitive advantage, it also increases risks, as they must trust the buyer to pay the invoice on time. Late payments or defaults can create cash flow problems for the supplier, especially if they depend on these payments to cover operational costs.
Despite these risks, many B2B businesses consider trade credit an essential strategy to win new business and retain existing customers. Trade credit helps boost sales, build customer loyalty, and gain a competitive edge by offering flexible payment terms. The potential for increased revenue makes trade credit a valuable tool for fostering growth and maintaining a competitive position in the market.
To maintain financial health, mitigating risk and optimizing cash flow efficiencies is essential when offering trade credit.
Mitigating risk and optimizing cash flow with AR financing
Businesses can utilize specialized cash flow solutions to manage the risks associated with trade credit and improve cash flow efficiency. Accounts receivable financing (AR financing) allows businesses to leverage their outstanding invoices to access immediate cash. This provides the supplier with immediate liquidity, reducing the impact of delayed payments and ensuring that their cash flow remains stable.
AR financing can take various forms, but the three major types are:
While each option operates slightly differently regarding ownership, risk, and customer interaction, they all provide businesses with immediate liquidity of receivables.
How AR financing works
AR financing benefits the borrower by providing quick access to cash, helping improve cash flow without waiting for customer payments. Although they all provide businesses with quick access to funds without waiting for buyers to pay their invoices, they perform differently:
Invoice Financing: Invoice financing allows businesses to borrow money against outstanding invoices. Companies can access immediate funds by using their accounts receivable as collateral. This helps improve cash flow without waiting for customers to pay their invoices.
Invoice Factoring: In invoice factoring, a business sells its outstanding invoices to a specialty lender (the factor) at a discount. The factor then takes over the responsibility of collecting payments from the customers. This provides the business with quick cash while the factor handles collections. Invoice factoring can be structured as “recourse” or “non-recourse.” In a recourse factoring agreement, the borrower remains responsible to pay the invoice value to the lender at the end of its trade credit term if the debtor defaults on payment. With non-recourse factoring, the lender assumes the risk of payment defaults.
Invoice Discounting: Invoice discounting is a financing option where a business borrows money against its unpaid invoices but retains responsibility for collecting customer payments. Unlike factoring, the company continues to manage its customer relationships and the risk of default while receiving immediate funding based on the value of its invoices.
By using AR financing, suppliers can effectively reduce the cash flow risks associated with trade credit. These solutions are particularly beneficial for businesses operating in industries with longer payment terms or unpredictable payment cycles.
The benefits of AR financing for suppliers
- Immediate Cash Flow: AR financing allows suppliers to access cash quickly without waiting for customers to pay their invoices. This enables them to cover operational costs, pay employees, and invest in growth initiatives without worrying about delayed payments.
- Improved Liquidity: AR financing helps businesses maintain healthy liquidity levels by turning unpaid invoices into immediate cash, ensuring they can meet their financial obligations on time.
- Flexible Funding: AR financing is a flexible solution, as businesses can choose to finance a portion or their entire receivables portfolio. This allows them to adjust their funding needs as their cash flow requirements change.
- Expandable Credit Limits: Because AR financing is based on the value of a company’s receivables, credit limits can expand as the company’s volume of receivables grows. This is highly advantageous to businesses in growth mode.
Why AR Financing is a smart solution for managing trade credit
Trade credit is an essential strategy for many B2B businesses. Its purpose is to allow buyers to purchase goods or services and defer payment, helping them manage cash flow while suppliers build customer loyalty and encourage repeat business. For businesses in growth mode, trade credit is an essential strategy to help increase growth but intensifies the company’s exposure to risk.
AR financing addresses the main cause of trade credit risk – the possibility that buyers may delay or fail to make payments, leading to cash flow issues and financial losses. By leveraging the value of accounts receivable to provide immediate access to capital, businesses can regulate cash flow and stabilize financial structures despite these risks. AR financing is a smart solution for managing trade credit.
Conclusion
While trade credit remains a valuable tool for many businesses, it can create cash flow challenges. AR financing provides a way to mitigate this risk and maintain steady liquidity, ensuring that suppliers can continue their operations without worrying about the timing of payments. Additionally, AR financing can help businesses take on new opportunities and expand without being held back by cash flow constraints.
In industries where trade credit is commonly used, such as retail, manufacturing, or wholesale distribution, AR financing can be an essential tool to help companies improve their financial health. It enables businesses to focus on growth and expansion without constantly managing the uncertainty of buyer payment schedules.
AR financing allows companies to remain agile, ensuring they can navigate the challenges of managing trade credit and maintaining liquidity.
Contact us to learn more about effective cash flow solutions to effectively manage the liquidity challenges associated with trade credit.
Key Takeaways
- Many B2B businesses consider trade credit an essential strategy to win new business and retain existing customers.
- To mitigate the risks of delayed and default payments, suppliers often arrange a financial arrangement to ensure reliable cash flow.
- Accounts receivable financing (AR financing) allows businesses to leverage their outstanding invoices to access immediate cash. This provides the supplier with immediate liquidity, reducing the impact of delayed payments and ensuring that their cash flow remains stable.
ABOUT eCapital
Since 2006, eCapital has been on a mission to change the way small to medium sized businesses access the funding they need to reach their goals. We know that to survive and thrive, businesses need financial flexibility to quickly respond to challenges and take advantage of opportunities, all in real time. Companies today need innovation guided by experience to unlock the potential of their assets to give better, faster access to the capital they require.
We’ve answered the call and have built a team of over 600 experts in asset evaluation, batch processing, customer support and fintech solutions. Together, we have created a funding model that features rapid approvals and processing, 24/7 access to funds and the freedom to use the money wherever and whenever it’s needed. This is the future of business funding, and it’s available today, at eCapital.
eCapital Corp
eCapital Corp. is committed to supporting small and middle-market companies in the United States, Canada, and the UK by accelerating their access to capital through financial solutions like invoice factoring, factoring lines of credit, asset-based lending and equipment refinancing. Headquartered in Miami, Florida, eCapital is an innovative leader in providing flexible, customized cash flow to businesses. For more information about eCapital, visit eCapital.com.