Accounts payable (AP) financing: How it works & key examples

We’re in an era of fiscal responsibility—also known as cost cutting. Small businesses have to be smarter than ever in how they spend, where they put their resources, and which growth initiatives they pursue. 

Every cent or penny counts. 

Smart financing is also critical. As your cash flow becomes unpredictable, having fast and strategic access to funds makes all the difference. And while many businesses already use bank loans, factoring, and crowdfunding to fill shortfalls, accounts payable financing is too often overlooked. 

This article explains what AP financing is, how it works, and why it’s such a valuable tool for SMBs. 

What are accounts payable (AP)?

Accounts payable are your invoices owed to suppliers and other creditors. Any purchase you make via invoice—with a total sum to be paid in future—is part of your accounts payable. And the amount of AP you have at any one time is known as your payables outstanding. 

Paying these sums on time and in full helps to create trusting, lasting relationships with suppliers. Pay late, or fail to pay the correct amount, and you risk penalties and even legal action. Perhaps worse, you develop a reputation as a business that doesn’t pay its bills. 

What is accounts payable financing?

Accounts payable financing lets you borrow working capital funds based on one or more of your unpaid AP invoices. If you owe a supplier a specific sum—as shown by an invoice—you may be able to borrow this sum from a third party provider. 

Accounts payable financing is also sometimes known as inventory financing or reverse factoring. There may be slight differences between these concepts—and providers specializing in one or the other—but they’re essentially the same idea. 

As with any form of financing, you make a commitment to repay the amount borrowed within a certain time period. There will also be a small fee or interest added, meaning the total amount paid can be higher than simply paying the supplier directly. 

But there are some real advantages to using accounts payable financing, particularly in the right circumstances. 

Why use AP financing?

Most SMBs that use AP financing will do so for a specific reason: you need to pay suppliers but don’t have as much capital available as they need. Or perhaps you have enough cash available, but paying off this invoice will make it harder to meet other costs. 

In these cases, AP financing can provide the extra liquidity you need to keep operating at a high level. 

Accounts payable financing has a few clear benefits for small businesses: 

1. You can pay suppliers on time and avoid any late-payment penalties.
2. You also avoid the awkward conversations that come with renegotiation outstanding credit. 
3. You can even pay in advance, which in many cases brings early-payment discounts or rewards. 

Overall, you have more choice over how and when you pay suppliers, and more control over your working capital. And you can have this without jeopardizing these vital relationships. 

Disadvantages of AP financing

AP financing is certainly an interesting option, but there are a few things to consider before you proceed: 

• Fees and interest. Not all providers charge interest, and there are low-cost options available. But you should always expect to pay more than the simple price owed to your supplier. You’re getting a service, after all. 
• More contracts to manage. Some modern providers make it quick and easy to take a financing contract. But in many cases, there’s a fair amount of administrative work involved. 
• Risk of spiralling debt. You already owe suppliers. AP financing helps resolve this issue, but you must ensure that you’re capable of repaying the third party provider on time as well. You can’t afford to have one debt chasing the other. 

How does AP financing work? 

AP financing sees a third party offer you immediate cash to cover outstanding costs. You borrow the money today, pay your suppliers immediately, then repay the lender within the agreed timeframe. 

This form of financing typically involves three main parties: 

• A buyer: Usually an SMB (you) owing money to the seller.
• A seller: Your supplier(s) who expect to be paid on time and in full. 
• A financing provider: This third party provides the cash required to fulfill the transaction on time. 

The key steps in a typical AP financing are as follows:

1. The buyer and seller first create a contract to supply goods or services. The seller issues an invoice, and the buyer agrees to pay at a later date. 
2. Needing help to pay this invoice, the buyer approaches a third-party payables financing provider.
3. The financing provider pays the seller directly, or transfers funds to the buyer, who then pays the seller. 
4. The buyer repays the loan to the financing provider at a later date, as agreed.

It’s a relatively simple process that nonetheless can become complicated.

Examples of AP financing

Here are two simple hypotheticals to show this process in action. 

Retail example

Shop X imports and sells clothing at several downtown Paris stores. It sources stock from international Supplier Y. Supplier Y delivers the clothing immediately, and Shop X agrees to pay Supplier Y in one month, once it’s had time to sell some of the products. 

Unfortunately, business is unseasonably slow, and one month isn’t enough time for Shop X to sell all of this stock. Knowing that better days are ahead, Shop X gets AP financing through a provider in order to pay Supplier Y on time. This buys Shop X two more months to sell these goods, and Supplier Y remains happy with the relationship. 

Service provider example

Agency A is hired to help Brand B build a new website and update their logo. It’s a big project requiring months of work. To complete the work, Agency A has to bring in Contractor C, a talented and experienced web developer. 

Brand B will pay Agency A upon delivery of the project, in three months. But Agency A needs to pay Contractor C monthly, before it receives payment for the project. This is a classic cash conversion cycle problem, and very common for agencies and service providers. 

If cash is an issue, Agency A can borrow funds to pay Contractor C on time, knowing that it will repay this loan in three months when the project is finalized. 

Financing accounts payable vs accounts receivable

These are two common tools used by businesses to optimize working capital. Both involve unpaid invoices, and both help to correct a cash conversion cycle that may be out of balance. 

But they’re fundamentally different parts of the process. Accounts receivable are the unpaid invoices you’re holding from customers. If the payment terms are long, or you’re struggling to collect, you can assign these receivables to a third party provider who will forward you the cash right away. This is essentially factoring, although there are some nuanced differences depending on the provider and their process. 

Payables financing is often also known as reverse factoring because it’s the other side of the cashflow coin. Instead of waiting to get paid on time by your customers, you’re the customer who risks not fulfilling the contract as agreed. 

How to choose an AP financing provider

Like factoring and invoice discounting, SMBs have used AP financing for a long time. And some traditional providers suffer from the same issues that make those other funding methods frustrating. 

Long waiting periods, endless admin, and a lack of flexibility can make AP financing an unappealing prospect. 

But not all providers are like this. Today, there are fast, efficient finance services that provide the cash you need within minutes. In general, look for AP services with the following characteristics:

• Low admin. Thanks to open banking technology, credit decisions can be made simply by connecting your bank or accounting tools. If you’re asked for endless documents—each individually—you can do better.
  
  
• Fast decisioning. As a result of the previous point, some financing providers offer near-instant decisions. You shouldn’t have to wait weeks or months to get the cash you need now.
  
  
• Digital-first processes. You really shouldn’t need to provide any hardcopy documents in this day and age. And you certainly shouldn’t have to go into a branch or have a sit-down meeting to secure short-term funding.
  
  
• Low fees and interest. Fast, efficient processes should also bring costs down. Low-cost services can be just as reputable and trustworthy as their slow, traditional counterparts. 
  
  
• High flexibility. You should be able to finance against the specific AP invoices you choose, refinance quickly, and end the relationship once you’ve repaid the funds. Flexibility means freedom for SMBs, and you shouldn’t have to feel trapped in awkward funding contracts.

Get the AP financing you need today

You needn’t go far to find all those factors we just discussed. Defacto offers fast, flexible, and fair financing for European SMBs, at a fraction of the cost. It takes as little as 27 seconds to check your eligibility and request a loan, and funding arrives right away.  

Most importantly, you’re fully in control of how and when you use the funds. You can repay when suits you (within the agreement, of course), and can refinance in seconds for your next project or pressing need. 

See how easy AP financing can be. Try Defacto today.