What You Should Know About Accounts Payable Financing

Ezra Cabrera | April 13, 2022


    Accounts payable financing is a new form of credit where businesses borrow money from a vendor in order to purchase said vendor’s goods or services. It’s also known as trade credit or vendor financing. Just like invoice factoring, qualifying for an accounts payable financing is based on the buyer’s creditworthiness. Most businesses don’t have to put up any collateral. But potential lenders need to review your credit history to see if you can qualify for a loan.

    Related: Invoice Factoring 101: Everything You Need to Know About Small Business Factoring

    For businesses in need of additional working capital, accounts payable financing is a great solution. With this type of financing, you don’t have to tap into your business assets or resources to purchase additional inventory. Other benefits include:

    • Building and establishing a great relationship with various vendors/suppliers.
    • Availing special discounts, bulk discounts, or special promos in the future. (Vendors often choose businesses with a great payment history when rationing their products.)
    • Gain a competitive advantage over other companies.

    How Does Accounts Payable Financing Work?

    With accounts payable financing, business owners typically provide credit to finance a percentage of the total price of the goods and services they’re purchasing.

    Once the business and the vendor agree, the business is required to make the initial payment. The remaining balance, along with accumulated interest, is paid off throughout the agreement. Interest rates may vary from 5% to 10%, although it can sometimes jump higher.

    Here’s a concrete example, assume Business A wants to purchase $100,000 worth of inventory from Vendor Z, but Business A doesn’t have enough working capital to finance additional inventory purchases. Business A only has $30,000 in cash and they’re looking to borrow the rest. Fortunately, Vendor Z is willing to negotiate a vendor financing agreement with Business A for the remaining $70,000.

    Vendor Z will charge a 10% interest on the loan, and Business A has to pay the debt within two years. Vendor Z also puts up the purchased inventory as collateral for the loan to protect itself against defaults.

    Why Do Businesses Prefer Accounts Payable Loans?

    There are two main reasons businesses opt for accounts payable financing:

    1. Substantial Amounts of Cash is Not Required

    Business owners who are short on working capital will benefit from the accounts payable loan option because it doesn’t require a substantial amount of working capital to fund the purchase of additional inventory. In accounts payable financing, business owners only have to pay a small percentage of the total cost of goods – usually, around 10% to 20% – and the remaining amount can be raised after acquiring the added inventory.

    2. Pay Debts with Business Profits

    With accounts payable financing, business owners do not need to pay the total amount of purchases upfront. Instead, they can make regular payments to the service loan using the income generated by their business. This makes it easier for business owners to repay the debt incurred from accounts payable financing compared to other types of loans.

    What are the Benefits of Accounts-Payable Funding

    Accounts-payable financing is best for businesses that don’t receive many customers or lacking assets to secure loans. Since it is unsecured, entrepreneurs can enjoy the injection of cash without worrying about guarantees. However, they may face higher fees associated with the high-risk nature of the arrangement. Despite that, it does offer a lot of advantages for both small and medium-sized businesses.

    Here are some:

    1. It’s Discreet

    The good thing about account-payable financing is that it minimizes the involvement of your customers and suppliers. Unlike invoice financing, people outside your company won’t know that you’re employing the help of a financing company.

    2. Business Optimization

    Since the arrangement is non-intrusive, many businesses utilize accounts payable loans to inject some cash into their business. This allows them to optimize their business financials and prepare for growth. Aside from that, the company also benefits from the maximum revenue that accounts payable loans can generate in their business.

    With accounts payable financing, businesses can:

    • Offer flexible payment terms to customers, thus, improving relationships.
    • Accept more projects
    • Replenish stocks
    • Prepare for the slow season

    3. On-time Payments

    Another advantage of accounts payable loans is that you won’t have to worry about missing payments to your vendors. The financing company will take care of your dues. All you have to do is to prove to the financing company that you’re capable of repaying the loans you take out.

    Do You Think that Accounts Payable Financing is Right for Your Business?

    In case you see yourself fit for this financing option, a lot of lenders now offer accounts payable financing with only the best terms. Since you’ll get to pay your payables on time, you can develop better relationships with your vendors. It also allows you to inject extra cash into your business and ensure business growth.

    About the Author

    Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.