What Is Account Payable Financing And What Does It Do For Your Business?

What is accounts payable?

Accounts payable (AP) is what a company owes its suppliers for goods and services purchased on credit. Accounts payable helps companies hold on to cash for a short period of time by delaying supplier payments, typically by a month or two.

A company's accounts payable is listed under the 'current liabilities' section of its balance sheet.

Good accounts payable management is crucial to maintaining supply chain stability, strong supplier relationships, and healthy cash flow.

What is accounts payable financing?

Accounts payable financing is a type of supply chain finance method used by businesses to raise funds to pay their suppliers. Under AP financing, a third-party financing company pays the supplier on the buyer's behalf while the buyer repays the lender at a future date. The buyer pays a service fee or interest to the third-party lender for agreeing to extend payment terms. The supplier might also have to pay the lender a fee and agree to an early payment discount on the outstanding invoice.

Here's how AP financing works in four steps:

1. The seller (supplier) delivers goods and/or services to the buyer and makes an invoice submission, which the buyer agrees to pay at a later date as per agreed upon payment terms.
2. The buyer approaches a third-party lender to help pay the outstanding invoice and signs a contract with it.
3. The lender pays the seller the invoice amount directly.
4. The buyer settles the due with the lender later.

Payable financing has multiple benefits, especially for small businesses with limited cash reserves:

• It helps them pay suppliers on time and avoid late fees and penalties.
• It usually comes with early payment discounts and other incentives that help save cash.
• Extending payment terms helps small businesses avoid cash flow strain.
• It also helps them maintain operational stability and build strong relationships with suppliers.

Benefits of early payment discounts

An early payment discount is an incentive offered by a supplier to a buyer to pay an invoice before it is due. It is usually a percentage of the invoice amount – for example, 2% off the invoice amount if the buyer pays the full amount within 20 days on a Net 30 payment schedule.

With payable financing, small businesses with fragile supply chain connections might get access to more early payments discounts than usual.

For the buyer, an early payment discount is more than a means to save money. It contributes to improving vendor relationships and business credibility, resulting in more favourable payment terms. Furthermore, using AP financing to avail of early payment discounts gives businesses some amount of predictability and control over how they pay their bills and manage cash flow.

Suppliers, too, benefit by offering such discounts. Receiving payments ahead of time stabilises their cash flow and saves them the trouble of chasing after late payers. And, by winning the loyalty of their customers, they gain greater business opportunities.

How accountants handle AP financing

If a company avails of AP financing, its accounting team must maintain correct documents and records, verify invoices, and ensure regulatory compliance. They must also coordinate with finance providers to ensure streamlined and timely payments. From an accounting perspective, monitoring cash flow to ensure uninterrupted operational activity is also part of AP financing management.

While there are no clear guidelines on payable financing reporting under various financial reporting standards, industry best practices recommend that the arrangement be beneficial to both buyers and sellers. Some suppliers view payable financing in a negative light, believing that big businesses use it to force small suppliers into extending payment terms. To counter this belief, businesses must ensure that an accounts payable financing programme is not only beneficial to suppliers but also optional.

Types of accounts payable financing

Accounts payable financing goes by different names at times – supply chain financing, supplier financing, vendor financing, trade financing, and reverse factoring. Payable financing usually takes two forms:

Buyer-led payable financing

This is just another name for the accounts payable financing we've discussed so far – an arrangement between a buyer, supplier, and financing company to pay the vendor invoice before it is due. The buyer gets an extended deadline to pay back the lender and, in most cases, a discount on the invoice amount.

Dynamic discounting

This is an accounts payable financing option where the buyer promises to pay the supplier before time in exchange for a discount on what it owes. These discounts are dynamic and depend on the payment dates set by the supplier – the earlier the date, the bigger the discount. Once the buyer and supplier reach an agreement, the buyer contracts a finance provider to pay the invoice.

Payable financing vs other financing options

Apart from accounts payable financing, there are various other financing options that businesses can choose from. Here are some prominent financing solutions and how they differ from AP financing:

Accounts receivable financing vs accounts payable financing

Accounts receivable (AR) financing is when a business uses its outstanding accounts receivable (customer invoices) as collateral to get funds from a third-party finance provider. It takes various forms, such as:

Accounts receivable loans: The business receives a loan from a bank or financing company against its accounts receivable. The loan amount is a percentage (say, 80%) of the total amount. The business retains ownership of the receivables and is responsible for collecting payment on them from customers.

Factoring: Under this method, the business sells its receivables at a discount to a factoring institution. It gives up ownership of the receivables and gives up the right to collect payment. Factoring is the most common form of AR financing but it can be expensive, incurring fees and interest rates.

The main difference between accounts payable financing and accounts receivable financing is that the former is initiated by the buyer and the latter by the supplier. Both improve cash flow – AP financing benefits the buyer and AR financing the supplier. While there are three parties involved in payable financing (buyer, seller, and financing company), there are only two in AR financing (supplier and lender). Another difference is that the supplier can choose to opt out of an AP financing arrangement and collect payment in full whereas the supplier must always settle for a discounted amount under receivable financing.

Payable financing is often called reverse factoring because it is the opposite of receivable factoring.

Invoice financing vs accounts payable financing

A sub-set of accounts receivable financing, invoice financing refers specifically to invoices while AR financing accounts for all methods of securing funds against accounts receivable. Invoice financing is supplier-initiated and improves the supplier's cash flow by accelerating invoice payments. Payable financing is buyer-focused and improves the buyer's cash flow by extending payment deadlines.

Forfaiting

Forfaiting is when an exporter sells their accounts receivable to a lender or forfeiter in exchange for cash. The forfaiter takes ownership of the receivables.

Business credit cards

Like AP financing, business credit cards are a source of working capital for businesses. However, they are more suited to covering smaller vendor payments and business expenses and might also incur higher fees.

Loans

Loans are a more general source of funding for businesses. Unlike payable financing, which is focused on extending payment deadlines to free up cash flow, loans can be used to take care of all kinds of business expenses. Loan amounts are fixed and lenders take the business' credit rating and debt repayment ability into account.

Business financing considerations

1. Understate your requirements: Check your business' cash flow cycles, working capital demands, financial health, and see if AP financing can meet your objectives. You'll also need to verify that your business qualifies for payable financing, which usually takes company revenue and credit rating into account.
2. Pick the right finance company: Different financial institutions have different requirements, so a thorough review is necessary. The rising popularity of fintech firms providing business financing options makes the range of choices even wider. before making your financing request, look for competitive fees, transparent processes, and easy accounting integrations while avoiding lengthy administrative procedures, long wait time, and lack of flexibility.
3. Weigh in cost considerations: Payable financing charges fees and interest, which shouldn't exceed the benefits of financing.
4. Negotiate payment terms: Set payment terms that are acceptable to all three parties involved. Communicate these clearly to avoid confusion.
5. Keep an eye on financial statements: While AP financing can improve cash flow, it also increases the short-term liabilities on the company's balance sheet.

Supply chain management and payable financing

Stable supply chains are a top priority for small businesses and accounts payable financing is the glue that holds these crucial links together. While payable financing is buyer-initiated, it supports suppliers in multiple ways, most of all by helping them get paid promptly. Through timely payments, AP financing ensures that suppliers – especially small businesses – have cash when they need it most and are able to control and manage cash flow more efficiently.

Supplier relationships and payable financing

With advantages for buyers and suppliers, accounts payable financing builds trust between the two parties. Strong supplier connections are crucial to running a business smoothly. High supplier turnover and supply interruptions are expensive and eat into company finances.

Accounts payable financing allows companies to pay their suppliers on time, boosting their reputation and creditworthiness in the eyes of the suppliers. As for the suppliers, they collect timely payments, which encourages them to offer rewards and discounts. By creating a win-win situation, AP financing contributes to long-lasting buyer-supplier relationships based on trust and good faith.

Heard of Aspire payable management?

Businesses can enhance the advantages of accounts payable financing by opting for digital tools that automate and streamline accounts payable processes, creating more value for buyer-supplier relationships.

Aspire is one such platform, offering a fully automated payable management system that helps businesses pay outstanding invoices accurately and on time. It boasts automated invoice capture and approvals workflows as well as scheduled payments, so you never miss a deadline on your vendor invoices. The end result: tighter control over cash flow and stronger partnerships with suppliers.

That's not all. Aspire also offers Advance Transfers, a trade credit programme under which we pay your vendors on your behalf and you get 51 days of interest-free extended payment terms.