Summary: A line of credit secured by Accounts Receivable (A/R) is a type of financing that uses your invoices as collateral. It provides a revolving line that allows companies to draw up to 85% of their A/R.
Several products can provide a line secured by invoices. Your product choice will be determined by your company’s size, history, financial health, and strategy.
Larger companies typically use bank lines of credit or asset-based loans. On the other hand, smaller companies often use sales ledger financing or invoice factoring.
This article provides an overview of each product and their qualification requirements. It will help you decide which product is best suited for your company. We cover the following:
- What is a line of credit secured by A/R?
- Bank line of credit
- Asset-based loan line of credit
- Sales ledger financing
- Invoice factoring
1. What is a line of credit secured by A/R?
A line of credit secured by your accounts receivable allows you to draw up to 80% – 90% of your A/R. They are implemented as revolving lines of financing and used to cover business expenses and new orders.
The line relies on your invoices as the primary collateral. Consequently, their credit quality is important. Invoices must be payable in net-30 to net-60 days to be eligible. Additionally, your clients must have good business credit.
There are several products that can provide a revolving line secured by your invoices. This article covers the four most popular alternatives:
- Bank lines of credit
- Asset-based loans
- Legered lines of credit
- Invoice factoring
2. Bank line of credit
The most well-known and cost-effective solution to finance your accounts receivable is a bank line of credit. Bank lines of credit have the lowest costs. However, their strict qualification and compliance requirements place them out of reach for many businesses.
Lines of credit can provide funding up to a preset limit, usually 80%-90% of your A/R. Your company can draw funds as needed and pay down the line as your invoices are paid.
The line is secured by A/R. However, most banks also encumber other company assets (e.g., inventory, machinery, etc.) Read “How does a business line of credit work?” to learn more.
a) Is it a fit for your company?
Lines of credit are usually the best solution for well-established companies with a reliable track record of profits. Due to their strict qualification requirements, they work best for companies with:
- Strong financial statements
- Reliable financial controls
- Stable revenues and profits
- Assets or cash flow
Most banks also require that the company’s owners meet additional criteria. These may include available personal assets and credit.
3. Asset-based loan (ABL)
Asset-based loans can provide a revolving line of credit when A/R is used as collateral. These lines are flexible and allow companies to draw up to 85% of their invoices. Most ABLs have dynamic credit limits that can be easily increased to match growing revenues.
One advantage of asset-based financing lines is that they have fewer covenants than comparable bank lines. Consequently, management and compliance are simpler. The trade off is that the line is somewhat more expensive than a bank line. Read “What are asset-based loans? How do they work?” to learn more.
a) Is it a fit for your company?
Asset-based lines of credit are typically used by small and middle-market companies. They have simpler qualification requirements than comparable bank lines of credit. To qualify, companies must:
- Invoice at least one million dollars/month
- Have reliable financing statements
- Use effective financial controls
- Have collateral
- Not have encumbered assets
Asset-based lines of credit may also be used by distressed companies and companies assigned to Special Assets. However, these companies must have a viable turnaround plan and be in productive negotiations with their existing lenders.
4. Sales ledger financing
Sales ledger financing, also called ledgered lines of credit, share many features of an ABL line of credit. Much like an asset-based loan, companies can draw up to 85% of their A/R. Credit limits are flexible and can grow with your revenues.
Ledgered lines have two advantages over asset-based loans. They have fewer covenants than a comparable ABL, making them simpler to operate. Additionally, ledgered lines are available to smaller companies. Companies that invoice at least $500,000 per month can qualify.
This solution is more expensive than a conventional asset-based loan. However, the flexibility of use and simpler qualification requirements make it an attractive option for many companies. Read “What is a ledgered line of credit? How does it work?” to learn more.
a) Is it a fit for your company?
Sales ledger financing is a good alternative for companies that cannot qualify for an ABL or prefer a simpler solution. To qualify, your company must:
- Invoice at least $500,000/month
- Be profitable
- Have reliable financial controls
- Not have A/R encumbered
- Not have legal/tax issues
5. Invoice factoring
Invoice factoring is typically used by smaller companies. However, it can be used by companies of any size that need a solution with few covenants and simple qualification requirements. Factoring lines can advance up to 85% (varies) of your invoices, though some industries qualify for higher advances.
This solution is expensive compared to the other options mentioned in this article. However, factoring is an alternative for companies that need an A/R line of credit but cannot qualify for other alternatives. Read “How does invoice factoring work?” to learn more.
a) Is it a fit for your company?
Invoice factoring lines are a good alternative for small companies, new businesses, or companies that cannot meet the requirements of the previous three options. Factoring lines are flexible and can be deployed quickly, making them a good alternative for companies with cash flow issues. The main requirements to qualify include having:
- Quality invoices
- Unencumbered A/R
- No serious tax or background issues
Do you need financing?
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Note: This article is for information purposes only and does not intend to provide financial advice. If you need financial advice, please consult a specialist.