Accounts payable teams always have to carefully balance two important priorities.
Keeping as much cash in the bank account for as long as possible is important for capitalizing on urgent opportunities.
On the other hand, paying suppliers quickly is critical for maintaining healthy vendor relationships and can even help you access early payment discounts.
Is there a way to achieve both goals?
Accounts payable financing is one potential solution, although it comes with some of its own downsides.
In this article, we’re going to help you understand whether accounts payable (AP) financing is right for your company, discussing pros and cons and comparing it to common alternatives.
What is accounts payable financing?
Accounts payable financing is a form of business financing that buyers use to fund purchases from a vendor.
It involves finding a third-party lender (such as a bank or AP financing specialist) to provide funds for the goods or services the buyer wishes to acquire.
The buyer receives the goods or services from the vendor, the third-party financing company pays that vendor, and the buyer consequently has a debt with the lender, which it pays off according to the terms of their agreement, including any interest charges or fees associated.
In some cases, the vendor may also pay a fee to the financing company, though most often, the lender will negotiate an early payment with the vendor.
AP financing goes under a few pseudonyms — vendor or supplier financing, reverse factoring, and supply chain finance. These all mean the same thing.
Who is involved in accounts payable financing?
There are three parties involved in accounts payable financing:
- The buyer: The company that wishes to purchase goods or services from the seller or already has and owes them money.
- The seller: The company that wishes to sell goods or services to the buyer or who has a pending invoice waiting to be paid by that customer.
- The finance provider: The company that provides funds. They pay the seller for the outstanding invoices and arrange repayment from the buyer.
How does AP financing work?
Broadly speaking, accounts payable financing is a fairly simple process.
Here’s what it involves:
- The buyer identifies an appropriate vendor for the goods or services currently required.
- The buyer applies for AP financing with a lender and establishes a contract that stipulates interest charges, fees, and repayment terms.
- The financing company contacts the vendor and negotiates a discount for early payment.
- The seller agrees (or negotiates), and the financing company releases funds.
- The buyer pays the full invoice amount to the lender, either through a repayment plan or in a lump sum sometime thereafter.
Through this process, the financing company has an opportunity to earn from two avenues. They charge interest on the buyer’s debt but can also negotiate with the seller to obtain an early payment discount.
For example, your invoice might be $10,000 with a vendor, which is the debt you take on with the lender. But they negotiate an early payment discount of 10%, so they only pay $9,000. The $1,000 gap is what they earn, plus any interest they charge you on the full $10,000.
AP financing is obviously beneficial for the lender then, but what about for buyers and sellers?
Accounts payable financing: Pros and cons
Like all forms of business financing — we’ll get into some alternatives shortly — AP financing comes with both benefits and disadvantages.
Pros of accounts payable financing
- Improved liquidity: Businesses using AP financing can keep more cash on hand to meet other needs, such as loan repayments or employee wages.
- Predictable cash outflow: You may be able to structure your debt repayment to the lender in a way that improves your control of cash flow.
- Quick resolution of accounts receivable: For the seller, AP financing is beneficial as it helps them collect on outstanding invoices quickly.
- Improve supply chain stability: Keeping your vendors happy is important for relationship management and improves the strength of critical supply chain components.
- Potential discounts: Using AP financing may allow you to access early payment discounts from the supplier, reducing your overall cost of operations.
Cons of accounts payable financing
- Credit risk: AP financing can be risky — like all forms of financing. It can damage reputation and credit rating more if a buyer defaults compared to other common financing methods.
- Account uncertainty: From an accounting perspective, AP financing is a little tricky. Because businesses don’t need to be as front-line publicly with how they are financing outgoings, it can lead investors to struggle when reviewing a company’s financial statements, which can put capital at risk.
- Reduced income: AP financing companies may negotiate heavy early payment discounts, which for sellers is a downside as it reduces their total revenue.
- Greater total costs: Accessing AP financing comes with fees and interest charges, which means you may end up paying more for goods and services acquired than you would have if you paid them using cash on hand.
Accounts payable financing compared to other forms of business financing
AP financing vs. trade credit
Trade credit involves receiving goods or services from a supplier now and paying later (usually within 30 to 60 days). There are typically no interest charges or fees involved.
AP financing requires a third-party lender to pay for the goods or services on your behalf, for which they later charge you interest and/or fees for access to that financing.
AP financing vs. bank loans
AP financing is only used when you wish to make a given purchase. The lender makes a payment to and deals directly with the vendor.
With a business loan, a financial institution pays you a lump sum, which you can use to invest in whatever your business requires. You’ll have structured loan repayments with interest rates that are generally lower than AP financing interest.
AP financing is generally for small purchases and short-term needs. Bank loans are used for the inverse.
AP financing vs. business credit cards
A business credit card gives you access to a predetermined amount of funds that you can use with any vendor.
AP financing involves having a third-party lender negotiate directly with and pay directly to your vendor. You pay them back later.
Business credit cards tend to have much higher interest rates, but they also typically offer interest-free payment periods of close to two months.
AP financing vs. line of credit
Accounts payable financing involves using a third-party financial institution to pay for goods or services acquired on your behalf, with an agreement to pay them at a later date.
A line of credit provides businesses with access to funds for diverse purchasing needs, and the lender does not get involved with the supplier or make payments directly to them.
Some lenders offering credit lines require you to put up collateral and tend to involve a more rigorous application and approval process.
Accounts payable financing vs. accounts receivable financing
Accounts receivable financing (which is also known as factoring, forfeiting, and invoice financing) is when vendors sell their long-term AR to a third-party vendor.
It's essentially borrowing against future income.
You’ve got a large invoice pending from a customer that you expect to receive payment from at some future point (in two months, say). You borrow from an AR financing institution, they give you the money now, and you pay it back (with interest) when the customer pays.
Accounts payable is when the seller takes out a loan to pay for their outstanding debt. The AP financing institution arranges to pay the supplier directly — often negotiating an early payment discount — and you pay them back, potentially with fees and interest on top.
Improving AP financing visibility with modern tools
Accounts payable financing is a useful option to have in your business financing arsenal.
It's not perfect for every situation — smaller purchases might be better managed with a business credit card, for example — but it can be a great solution for taking advantage of early payment discounts on large invoices.
Your best bet is to have access to a range of business financing options and ensure all of them are neatly integrated into an AP automation and expense management system. This will help you maximize visibility over outstanding debts and access data-driven insights and forecasting for better business decision-making.
BILL, our financial operations system, supports modern AP teams with powerful features like:
- Deep customizable accounts payable automation
- Insightful reporting options
- Access to business credit lines and company credit cards
We also offer native integrations with the rest of your tech stack — like Xero and QuickBooks — and an API for connecting with third-party suppliers, like your AP financing solution.
Start using BILL today and transform your accounts payable workflows.
