receivable financing

DEFINITION OF 'ACCOUNTS RECEIVABLE FINANCING'

A type of asset-financing arrangement in which a company uses its receivables which is money owed by customers - as collateral (In lending agreements, collateral is
a borrower's pledge of specific property to a lender, to secure repayment of a loan.[1][2] The collateral
serves as protection for a lender against a borrower's defaultthat is, it can be used to offset the
loan to any borrower failing to pay the principal and interest under the terms of a loan obligation. If a
borrower does default on a loan (due to insolvency or other event), that borrower forfeits (gives up)
the property pledged as collateral, with the lender then becoming the owner of the collateral)

in a

financing agreement. The company receives an amount that is equal to a

reduced value of the receivables pledged. The age of the receivables have a
large effect on the amount a company will receive. The older the receivables, the
less the company can expect. Also referred to as "factoring".

INVESTOPEDIA EXPLAINS 'ACCOUNTS RECEIVABLE

FINANCING'
This type of financing helps companies free up capital that is stuck in accounts
receivables. Accounts receivable financing transfers the default risk associated
with the accounts receivables to the financing company; this transfer of risk can
help the company using the financing to shift focus from trying to collect
receivables to current business activities.
Accelerate cash flow, improve collections, and control exposure to bad debts with accounts receivable financing (also
called factoring) and purchase order financing from the Commercial Services group at Wells Fargo Capital Finance. If
your company has creditworthy business-to-business or business-to-government accounts receivable, we can help
you obtain the

Extending credit to your customers is a normal part of doing business. It is also a good way to increase
revenue and build your customer base. However, when you carry a significant amount of sales as
accounts receivable on your books, those funds are not available for other uses. Financing receivables,
better known as accounts receivable financing, is a way to quickly convert receivables into cash.

Description
When you use accounts receivable financing, also called invoice financing, you sell the
unpaid invoices of customers to a factoring company. Once a shipment is delivered and the
customer is invoiced, the factoring company advances 70 percent to 90 percent of the value
of the invoice. In some cases you may receive the cash within 24 hours. When your

customer pays the bill to the factoring company, it sends you the remaining balance, minus
a fee. Fees typically run about 1 percent of the invoice amount.

Benefits
The primary benefit of accounts receivable financing is that you collect most of
the money owed in a short time. These funds are then available to pay expenses.
Because you sell the invoices, rather than borrowing against them, you do not pay any
interest and you do not have to list an additional liability on your balance sheet. Factoring
companies normally share their credit analysis of customers with you, so you gain
information that will be useful when doing business with these customers in the future.

Disadvantages
When you sell receivables to a factoring company, you are still liable if a customer
does not pay the bill. For this reason, you need to be sure customers are
creditworthy. Another consideration is that the fees, although usually small, reduce your
profit margin. It is important to make certain the factoring company is professional and
mindful of customer relations. An aggressive collection policy on the part of the factoring
company may alienate your customers.

Value to Startups
Accounts receivable financing can be a valuable tool for a new business or one
that is struggling to recover from setbacks. Because you sell the receivables
instead of borrowing against them, no credit history is required and there are no
loan payments to make. Firms can even use receivables financing if they have tax liens or
are in Chapter 11 bankruptcy.

with recourse, notification basis, and contingent liability

pledging of accounts receivable

Accounts receivable pledging is when a businesses uses its accounts receivable asset as
collateral on a loan, usually a line of credit.

When accounts receivable are used as collateral on a loan (In finance, a loan is a debt provided by

one entity (organization or individual) to another entity at an interest rate, and evidenced by
a note which specifies, among other things, the principal amount, interest rate, and date of

repayment. A loan entails the reallocation of the subject asset(s) for a period of time, between
the lender and the borrower. In a loan, the borrower initially receives or borrows an amount
of money, called the principal, from the lender, and is obligated to pay back or repay an equal
amount of money to the lender at a later time.), the lender typically limits the amount of the loan to
either:

70% to 80% of the total amount of accounts receivable outstanding; or

A percentage of the accounts receivable that declines based on the age of the receivables.
The latter alternative is safer from the perspective of the lender (and is therefore more commonly
used), since it allows for more specific identification of those receivables least likely to be collected.
For example, a bank may not allow any accounts receivable to be used as collateral if they are more
than 90 days old, 80% of all receivables between 30 and 90 days old, and 95% of all receivables that
are 30 days old or less. The lender may also specifically exclude any receivables for which the
company has granted unusually long payment terms. By being this conservative in calculating the
maximum amount to be loaned, the lender protects itself from issuing debt that cannot be fully offset
by collateral in the event of a payment default.
Under an accounts receivable pledging arrangement, the company subject to the arrangement
completes a borrowing base certificate following the completion of each reporting period, and forwards
the signed certificate to the lender. The lender may also require that a copy of the month-end
accounts receivable aging report be forwarded along with the certificate, in case the lender wants to
trace the amounts on the certificate back to the underlying accounts receivable detail. This request is
most commonly made at the end of the year, not for each monthly certificate.
The borrowing base certificate itemizes the amount of accounts receivable outstanding at the end of
the reporting period into the age brackets specified by the lender, calculates the maximum amount of
borrowing allowable based on the amount of accounts receivable, and states the amount actually
borrowed. The lender uses this certificate to monitor the amount of collateral available, and whether it
needs to adjust the amount of debt available to the company.
If the amount of debt outstanding exceeds the amount of accounts receivable stated in the borrowing
base certificate, the borrower must pay this amount back to the lender.
Under a pledging agreement, the company retains title to and is responsible for collecting accounts
receivable, not the lender. Even though the lender now has a legal interest in the receivables, it is not
necessary to notify customers of this interest.

Alternative term for accounts receivable financing.

Businesses resort to various means to finance operating activities and remain

economically afloat. Traditional funding procedures involve the issuance of debt or
equity products in public markets or through private conduits. Other forms of
business financing include pledging accounts receivable, funding through fixedasset attachment procedures and factoring customer receivables.
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Definition

Accounts receivable pledging is a practice in which a company uses

money it expects from customers -- that is, customer receivables -- as
collateral for a loan. This process enables the business to fund its operating
activities at a cost that may be cheaper than a traditional loan's rate. What's
more, the organization retains the title to the receivables, meaning it still
owns them and can classify them as short-term assets on its balance sheet.
A short-term asset is a resource a company can sell -- or convert into cash -in the next 12 months. Examples include cash, prepaid expenses and
merchandise.

How It Works

The pledging process starts with department heads and corporate

leadership discussing the company's funding woes, studying fund-raising
alternatives to pledging and coming up with a list of account receivables to
commit. Then the company's credit managers review the list with lenders,
who heed the quality of the receivables -- particularly customers' payment
profiles and creditworthiness, along with the length of time they've been
doing business with the organization. The next step is determining the loanto-value ratio, a metric that enables the company to receive funding but not
get its way in the entire pledging process. In other words, a lender maintains
some leverage in the credit process by advancing only a portion of
receivables pledged. For example, an organization pledges $1 million worth
of receivables and the loan-to-ratio is 75 percent. Consequently, the business
receives $750,000, or $1 million times 75 percent. After determining the
loan-to-value metric and signing a formal contract, the creditor files a lien on
the receivables, allowing the lender to collect on the receivables if the
borrower eventually defaults.

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Relevance

Pledging is a form of off-balance-sheet financing; that is, a company

doesn't record its receivables along with the corresponding debt. This frees
up capital, reduces regulatory scolding and eases the concerns of the
organization's existing contingent of creditors. Receivables pledging may free
up capital, because it doesn't give rise to additional debt reporting -- a boon
for companies in industries, such as banking and insurance, where regulators
require certain debt-to-capital ratios.

Accounts Receivable Factoring

Besides pledging, a company may factor its receivables to raise

operational cash. Factoring expected client remittances means selling the
receivables outright to a lender. As a result, the business cedes the
receivables title to the creditor. The company notifies customers to send
payments directly to the lender.

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assignment of accounts receivable

DEFINITION OF 'ASSIGNMENT OF ACCOUNTS

RECEIVABLE'
A lending agreement, often long term, between a borrowing company and a
lending institution whereby the borrower assigns specific customer accounts that
owe money (accounts receivable) to the lending institution. In exchange for
assignment of accounts receivable, the borrower receives a cash advance for a

percentage of the accounts receivable. The borrower pays interest and a service
charge on the advance.

INVESTOPEDIA EXPLAINS 'ASSIGNMENT OF

ACCOUNTS RECEIVABLE'
If the borrower retains ownership of the accounts, then the borrower continues to
collect the accounts receivable and passes the payments on to the lender. Since
the borrower retains ownership, he also retains the risk that some accounts
receivable will not be repaid. In this case, the lending institution may demand
payment directly from the borrower. This arrangement is called assignment of
accounts receivable with recourse. Assignment of accounts receivable should not
be confused with pledging or factoring of accounts receivable.
Assignment of accounts receivable is an agreement between a lending company and a borrowing
company in which the later assigns its accounts receivable to the former in return for a loan. By
assignment of accounts receivable, the lender gets a right to collect the receivables of the borrowing
company if it fails to repay the loan in time. The lender also receives finance charges and service
charges.
It is important to note that the receivables are not sold/transferred under an assignment agreement.
If the receivables have been transferred, the agreement would be of sale/factoring of accounts
receivable. Usually, the borrowing company would itself collect the assigned receivables and remit the
loan amount as per agreement. It is only when the borrower fails to pay as per agreement, that the
lender gets a right to collect the assigned receivables on its own.
The assignment of accounts receivable may be general or specific. A general assignment of accounts
receivable entitles the lender to proceed to collect any accounts receivable of the borrowing company
whereas in case of specific assignment of accounts receivable, the lender is entitled only to collect the
accounts receivable specifically assigned to the lender.
The following example shows how to record transactions related to assignment of accounts receivable
via journal entries:

Example
On March 1, 20X6, Company A borrowed $50,000 from a bank and signed a 12% one month note
payable. The bank charged 1% initial fee. Company A assigned $73,000 of its accounts receivable to
the bank as a security. During March 20X6, the company collected $70,000 of the assigned accounts

receivable and paid the principle and interest on note payable to the bank on April 1. $3,000 of the
sales were returned by the customers.

How Receivables Assignment Works

Assigning your accounts receivables means that you use them as collateral for a secured
loan. The financial institution, such as a bank or loan company, analyzes the accounts
receivable aging report. For each invoice that qualifies, you receive 50 to 85 percent of the
outstanding balance in cash. Depending on the lender, you may have to assign all your
receivables or specific receivables to secure the loan. Once you have repaid the loan, you
can use the accounts as collateral for a new loan.

Assignment Strengths and Weaknesses

Using your receivables as collateral lets you retain ownership of the accounts as long as you
make your payments on time. Since the lender deals directly with you, your customers never
know that you have borrowed against their outstanding accounts. However, lenders charge
high fees and interest on an assignment loan. A loan made with recourse means that you
still are responsible for repaying the loan if your customer defaults on their payments. You
will lose ownership of your accounts if you do not repay the loan per the agreement terms.

What is the purpose of assigning accounts receivable?

The purpose of assigning accounts receivable is to provide collateral in order to
obtain a loan.
To illustrate, let's assume that a corporation receives a special order from a new
customer whose credit rating is superb. However, the customer pays for its
purchases 90 days after it receives the goods. The corporation does not have
sufficient money to purchase the raw materials, pay for the labor, and then wait 90
days to collect the receivable. The corporation's bank or a finance company may
lend 80% of the receivable but insists that the receivable be assigned to them as
collateral for the loan.
Assigning a specific account receivable usually results in recording the receivable in
a separate general ledger account such as Accounts Receivable Assigned. Some
lenders require that the corporation's customer be notified of the assignment and
that the customer must remit the receivable amount directly to the bank.
Instead of assigning a specific receivable, the lender may require the corporation to
assign all of its receivable as collateral for a loan.

Receivable Financing
-

raising money out of its receivables

a type of asset-financing arrangement in which a company uses its
receivables - which is money owed by customers - as collateral

financing agreement
this type of financing helps companies free up capital that is stuck in
accounts receivables. Accounts receivable financing transfers the
default risk associated with the accounts receivables to the financing
company; this transfer of risk can help the company using the
financing to shift focus from trying to collect receivables to current
business activities.

Receivable financing with:

recourse: this means that in case collections from customers are not
sufficient to cover loans or cash advances made by the financing
institutions, the latter can collect from the debtor of the company
notification basis: this means that the customers are notified of the
transfer of receivables so that they have to pay the financing company
contingent liability: refers to liability that may arise depending on certain
conditions

Common forms of receivable financing

Pledging of accounts receivable
Assignment of accounts receivable
Factoring of accounts receivable
Discounting of accounts receivable

Pledging of accounts receivable

-

loans may be obtained from banks and other financial

institutions by pledging accounts receivable as security for
the payment of the loan

pledged as collateral security for the payment of the loan

borrower still makes the collection of the pledged accounts
and turns over the collection to the bank to pay for the loan

Entry:
Example: On Nov. 1, 2009, an entity borrowed P1,000,000 from PNB and issued a promissory note for the
same. The term of the loan is one year and is discounted at 12%. The entity pledge accounts receivable of
P2,000,000 to secure the loan.

Assignment of accounts receivable

-

Entry:
Example:

refers to their conditional sale, that is, the assignee can collect
from the assignor in case the collections are insufficient to
cover the amount advanced to the latter
means the borrower (called assignor) transfers it rights in
some of its accounts receivable to lender (assignee) in
consideration of the loan
usually the lender/assignee lends only a certain percent (70%,
80% or 90%) of the face value of the accounts because the
accounts may not be fully realized (sales discount, sales
returns, uncollectible accounts)