Summary: A ledgered line of credit is a type of asset-based financing that enables companies to draw up to 85% of their Accounts Receivable (A/R). Ledgered lines are more flexible, easier to use, and simpler to manage than comparable solutions.
This article explains how ledgered lines work, their advantages, qualification requirements, and how they compare to other options. We cover the following:
1. What is a ledgered line of credit?
A ledgered line of credit, also called Sales ledger Financing, provides companies with a revolving line secured by their Accounts Receivable (A/R). Most lines allow a company to draw up to 85% of its open invoices. However, the percentage can vary. The line gets paid down as your clients pay their invoices.
Ledgered lines are simple to operate. Companies access funds by submitting a draw request to the factoring company. The draw request typically contains a list of invoices along with copies of each invoice.
The credit limit is set as a percentage of your open invoices, typically 85%, not to exceed a certain amount. However, the credit limit is adaptive and can be increased quickly. The main requirements are to have eligible invoices, run a profitable business, and keep good financial records.
a) Pricing
Most ledgered lines are priced using a “Prime + X%” model, where Prime is the Prime Rate or similar benchmark. Some lines may also charge a fee per invoice.
2. Advantages
Sales ledger financing lines have several advantages over other solutions. Many companies prefer them due to their ease of use and simpler compliance requirements. The most important benefits include the following:
a) Improves cash flow quickly
Ledger lines are designed to improve a company’s cash flow. Lines can usually be developed quickly, which is helpful for companies that need to improve their working capital.
b) Few covenants
Ledgered lines have few covenants, so compliance is easier than with a bank line of credit or similar solution. This benefit is important if your company only wants to finance accounts receivable and prefers simpler line management.
c) Draw funds easily
Drawing funds from the line is easy. It can typically be done by submitting a list of invoices and copies of the invoices or similar documents.
d) Simple qualification criteria
Sales ledger financing lines have simpler qualification criteria than asset-based loans and bank lines of credit. This makes them attractive to growing small businesses that can’t meet the stringent requirements of a bank lender.
3. Qualification criteria
Ledgered lines are intended for companies with at least $6 million in yearly revenues. These lines work well for small and middle-market businesses.
The company must be well managed, have good accounting, and be profitable. Here is a summary of the main requirements.
a) Minimum revenues
Ledgered lines typically require a company to invoice at least $500,000 per month. They can work with companies that have seasonal revenues, provided their yearly revenues average $6 million.
b) Profitable
This solution is available only to companies that can show a profit. Unfortunately, this option is unavailable for distressed companies going through a turnaround.
c) Creditworthy commercial clients
Your clients must have good commercial credit and pay their invoices within 30 to 70 days. Clients and invoices that don’t meet this criteria generally aren’t eligible for financing.
d) Accurate accounting
The company’s accounting system must have up-to-date information. At a minimum, the company must be able to provide:
- Profit and loss statement
- Balance sheet
- A/R Aging report
e) Reliable controls
Your company must have a reliable invoicing and collections process. Invoices must be sent to clients promptly and tracked to ensure a timely payment.
f) Unencumbered Accounts Receivable
Sales ledger financing relies on A/R as the primary collateral for the transaction. Consequently, your invoices cannot be encumbered by other financing (e.g., bank loans, etc.)
g) No major tax or legal issues
Your company must be free of major tax or legal issues. Companies with legal or tax problems should consider other alternatives, such as factoring.
4. Comparison with other products
Ledgered lines of credit are typically used by companies that have outgrown their factoring line but aren’t ready for an asset-based loan. Consequently, ledgered lines are typically compared against these two products.
a) Invoice factoring
Ledgered lines and invoice factoring offer similar benefits. However, ledgered lines are simpler, cheaper, more flexible, and have fewer controls than a comparable factoring line.
Drawing funds from a factoring line is done by submitting a schedule of accounts, along with invoice copies and additional documentation. Ledgered lines, on the other hand, have a simpler process of drawing funds.
Additionally, most factoring lines regularly verify invoices with your customers as part of their controls. This is typically done through vendor portals. However, verifications can also be done via email or phone.
Read “How does invoice factoring work?” to learn more.
b) Asset-based loans
Ledgered lines provide many of the benefits of an asset-based line of credit. However, they have simpler qualification and compliance requirements than asset-based loans. They are also easier to use and maintain.
For example, asset-based loans allow you to draw funds by submitting a borrowing certificate. Generating the certificate typically requires your accounting to be updated and reconciled.
One drawback is that ledgered lines are slightly more expensive than an asset-based loan of comparable size. For most smaller companies, the benefits of a ledgered line typically outweigh this drawback.
Read “What is an asset-based loan? How does it work?” to learn more.
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