Accounts Receivable Financing And How It Can Help You

Accounts receivable financing is a flexible form of short term, asset-based commercial financing. Receivables factoring is a common form of this type of financing. In most cases receivables factoring is structured as a sale transaction. It is not a debt or loan transaction. A trading business sells its accounts receivables amount to factoring or invoice discounter firm. This type of transaction may also be referred to as invoice factoring and is a form of asset securitization.

Ownership of the receivables balance is legally assigned or transferred to the factor firm. The transaction remains confidential. In many jurisdictions, there is no requirement to formally advise the debtors of the transaction.

The sale transaction proceeds at a price discounted below the nominal receivables value recorded in the financial books of the trading business. The trading business selling its receivables receives an immediate payment. That immediate disbursement is only a portion of the total value agreed for the receivables. Further payments will be made by the invoice discounter as the receivables are collected.

The price paid by an invoice discounter to a business for its receivables balance depends on a various factors including the average size of the outstanding invoices owed by debtors, the number of customer debtors, their credit rating or creditworthiness, the average length of the collection period, and the average age of the outstanding invoices (the longer the debt has been outstanding the lower the price paid by the invoice discounter).

Compared to banks, factoring firms focus entirely on one asset (the receivables) rather than the whole business. By contrast, the loan approval process of a bank is totally different. They focus on the overall financial performance and credit history of a business, its cash flow and its available security or collateral. Many small-to-medium, early life cycle firms have difficulty in meeting bank lending criteria. They typically have few assets, a weak balance sheet and a no credit history. Provided they trade and have a reasonably large accounts receivable balance, factoring may be a suitable option.

Factoring firms adopt two alternative approaches to the risk of non-payment by debtors (debtor default). These two approaches are reflected in the transaction structure or documentation. Non-recourse sees the factoring firm take on all non-payment risk and no recourse for compensation from its customer, the trading business. Without appeal factoring involves the opposite situation, all debtor risk is carried by the trading business.

In a factoring context, the efficient collection of outstanding amounts from debtors is a critical task. It is an ongoing concern for the trading business keen to maintain a harmonious relationship with customers. If the trading business sells its receivables on a non-recourse basis, over-aggressive collection tactics by the factor firm may result in the loss of customers. For this reason, a trading business may choose to conduct the transaction without appeal.