Accounts receivable financing enhances cash accumulation

Every day, businesses across the country generate accounts receivable balances by selling goods and services to their customers. The seemingly immeasurable value of accounts receivable is consistently generated and replenished on the business’ balance sheets.

The challenge the business faces is that these balances normally do not appreciate and sometimes take a long time to collect. An innovative financial strategy may be available to use this ubiquitous business asset to produce significant opportunities for business owners.

This concept uses other people’s money without interrupting the flow of accounts receivable. While this was originally designed to work with physicians who typically carry large medical receivables, it has now evolved to work with most business owners.

The strategy is called accounts receivable financing. Banks or other lending sources may loan the business money based on its annual average accounts receivable balance. This is not to be confused with factoring or selling your accounts receivable balances, which can result in losing control or a reduced value of the receivables. With accounts receivable financing, normally a simple interest payment is made on this loan. The business owner can use this money as a bonus for himself or to other key employees and purchase a financial product that will grow on the compound growth curve.

A misunderstanding people have is thinking the simple interest loan rates may exceed the return crediting rate which could eliminate the value of this program.

The reality is that due to the effects of compounding, the program can still produce significant positive cash accumulation over time, even in an inverted interest rate environment. This is known as an interest rate arbitrage.

If you compare past history, when loan interest rates climb, normally the crediting rates of a well-positioned asset will increase proportionally. This increases the value of compounding interest. The longer this interest rate arbitrage is in place, the greater the growth in the spread.

A few examples of businesses that have benefited from accounts receivable financing include accounting firms, chiropractors, consulting firms, law firms, dentists, engineering firms, funeral homes (pre-need), auto dealerships, manufacturers and physicians.

Not all companies will benefit or qualify for this program, so it’s important to work with a CPA and financial adviser. The ideal candidates are businesses that have strong cash flow and have a need to fund their retirement or want to offer executive benefits to key employees.

Simple vs. Compound Leveraged Investment Comparison

This illustration assumes a loan amount of $500,000, an interest-only loan rate of 8.5 percent, an investment yield of 8 percent, and a tax rate of 30 percent.

Without Tax Deduction

Year of Participation Simple Interest Compounded Investment Value Net Gain from Compounding

1 $42,500 $540,000 ($2,500)

5 $212,500 $734,664 $22,164

10 $425,000 $1,079,462 $154,462

15 $637,500 $1,586,084 $448,584

20 $850,000 $2,330,478 $980,478

25 $1,062,500 $3,424,237 $1,861,737

30 $1,275,000 $5,031,328 $3,256,328

With Tax Deduction

Year of Participation Simple Interest Compounded Investment Value Net Gain from Compounding

1 $29,750 $540,000 $10,250

5 $148,750 $734,664 $85,914

10 $297,500 $1,079,462 $281,962

15 $446,250 $1,586,084 $636,834

20 $595,000 $2,330,478 $1,235,478

25 $743,750 $3,424,237 $2,180,487

30 $892,500 $5,031,328 $3,638,828

Alan Lockhart is president of Marketing Financial, a wholesaler of financial products. He can be reached at alan@marketingfinancial.com.