Online Calculator | Accounts Receivable Financing May Possibly Involve A Firm Marketing Its Debtors At A Low Cost

Accounts Receivable Financing May Possibly Involve A Firm Marketing Its Debtors At A Low Cost

Accounts receivable financing is a relatively specialized form of business financing some people refer to it as a form of lending. Although it may misleadingly be referred to as a loan and even in practice seem like a loan, from a legal perspective, this is misleading since transactions are structured as a sale not a loan. Funds are advanced by a factoring receivables firm to an operating business against its receivables balance.

Receivables factoring is also called invoice factoring. It is a type of asset securitization. From a legal standpoint, the operating business sells its accounts receivable financing to the factoring firm. They are owned by the factoring firm, although from a business perspective that is not visible to customers. The business continues operating as normal, including completing the collection of the receivables.

The sale of receivables is concluded at a discounted price below the financial value stated in the books of account. Once the documentation is completed, the trading business receives an immediate advance, being some high proportion (say, 80 percent) of the total agreed transaction value. The remaining sale price is retained by the factoring firm to cover transaction fees, interest costs and a safety margin in case debtor defaults are higher than expected. Further advances are released by the factoring firm as the receivables are collected by the business and the advance repaid.

The discounted price paid by a factoring firm for the receivables varies mainly with the average size of the outstanding invoices, the number of customers, the credit standing of the customers, and the average collection period. The discount applied by the factoring firm will increase the larger the average size of outstanding invoices, the smaller the number of customers, the poorer the credit standing of the customers and the greater the age of the outstanding balances.

Compared to factoring firms, banks focus on vastly different lending criteria. Their lending decisions are mainly based on credit and overall financial history, cash flow and security or collateral. Most small and medium sized firms early in their life cycle, with few assets and a weak balance sheet or a history of financial problems find it difficult to secure loans from a bank.

Factor firms generally offer two alternatives regarding the risk of debtor default. These two transaction structures are known as non-recourse factoring and without appeal factoring. Non-recourse factoring involves the factor firm assuming all risk of non-payment by debtors and it has no recourse back to the trading business if non-payment occurs. By contrast, without appeal factoring involves all risk of debtor default remaining with the trading business; the cost of any non-payment is pushed back by the factor firm to the trading business and it has no appeal against that cost.

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.

The asset based finance industry is large. Some estimates place the value of factoring receivables transactions in the USA market at more than $150 billion per annum. Factor firms or invoice discounters offer to buy the invoices of a business for a discount of 10 to 40 percent on a non-recourse basis that means it is assuming full risk of non-payment. In addition to the discount, the trading business is also charged an ongoing periodic fee (usually monthly) during the life of the transaction and an interest cost based on the sum initially advanced by the factor firm to its customer.

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