Receivables Financing

Receivables financing is a term used to refer to the process of a business raising additional funding using the value of its balance sheet accounts receivable, which represent amounts owed by customers for goods and services sold to them on credit terms.

There are three methods of using receivables financing to raise additional finance, factoring, assigning, and pledging.

Factoring Receivables

Invoice factoring means that the accounts receivable are sold at a discount to a factoring company for cash. In return for a fee, the factoring company undertakes to collect the accounts receivable from the customer and to advance a percentage of the face value of the outstanding amounts, with the remaining balance paid when the amounts have been collected from the customer.

As the accounts receivable are sold, they are removed from the balance sheet and any discount (loss) on sale is shown as an expense in the income statement.

Receivables Financing – Factoring of Receivables Example

Consider an example, suppose a business has accounts receivable of 50,000 due from customers on 45 day terms, and uses invoice factoring to raise additional funding. The factoring company agrees to purchase the outstanding accounts for a 5% discount fee (2,500), and also offers to advance the business 85% (42,500) of the face value of the accounts receivable, with the balance to be paid in 45 days when they are collected from the customer.

The main receivables financing journals are shown below. Additional journals relating to factoring can be found at our Factoring Accounts Receivable Journal Entries Reference.

The business records the original sale to the customer
Account Debit Credit
Accounts receivable 50,000
Revenue 50,000
The accounts receivable are sold to the factoring company
Account Debit Credit
Accounts receivable 50,000
Cash (50,000 x 85%) 42.500
Loss on sale of receivables (50,000 x 5%) 2.500
Due from factoring company 5,000
Total 50,000 50,000

The balance due from the factoring company represents the face value of the accounts receivable (50,000), less the advance (42,500), less the fees (5,000), and will be paid to the business when the factoring company has collected the full amount from the customers.

The journals above refer to non-recourse factoring where the factoring company accepts full responsibility for the accounts receivable and their collection and cannot go back (has no recourse) to the business in the event of bad debts occurring. Alternative forms of factoring known as with-recourse factoring are available in which the business retains the risk of bad debts.

Assignment of Receivables

The second form of receivables financing is referred to as an assignment of receivables. Unlike factoring, in assignment of receivables, the outstanding invoices are not sold, but are assigned to a finance company. The assignment agreement effectively gives the finance company the right to receive the cash flows from specific customer invoices, and provides collateral against which. in return for a fee and interest, the financing company makes a loan to the business.

As the accounts receivable are not sold, they are not removed from the balance sheet of the business, and any cash advance received by the business becomes a loan or note payable from the financing company.

Receivables Financing – Assignment of Receivables Example

Consider an example, suppose a business has accounts receivable of 50,000 due from customers on 45 day terms, and uses assignment of receivables to raise additional funding. The financing company agrees to advance 85% (42,500) of the outstanding accounts for a 1% fee (500), and also charges interest on any advance at the rate of 10% on the outstanding advance balance. The remaining balance is to be paid in 45 days when they are collected from the customer.

The main receivables financing relating the the assignment of accounts receivable are shown below. Additional journals relating to assignments can be found at our Assignment of Accounts Receivable Journal Entries Reference.

The receivables financing journals would be as follows:

The business records the original sale to the customer
Account Debit Credit
Accounts receivable 50,000
Revenue 50,000
The accounts receivable are assigned to the finance company
Account Debit Credit
Accounts receivable 50,000
Accounts receivable assigned 50,000
Loan or note payable 42,500
Cash 42.000
Financing fee 500
Total 92,500 92,500

With the assignment of receivables, the accounts receivable are not removed from the balance sheet but are transferred to a separate account called Accounts receivable assigned, in order that cash received from the customers can be allocated to the assigned invoices and repayment made to the finance company. The receipt of cash from the advance is then recorded as a loan or note payable and the fee is recorded as an expense.

Interest is now charged on any outstanding advance balance at the rate of 10%. In the above example at the end of the accounting period (month), the business would accrue an interest expense of 42,500 x 10%/12 = 354 in the usual manner.

Pledging Accounts Receivable

The final method of receivables financing is called pledging. When accounts receivable are pledged, the asset is simply used as collateral for a loan. The finance company does not have the right to cash flows from specific invoices, it simply has the right to use the accounts receivable as security in the event that the terms of the loan are not adhered to.

Receivables Financing – Pledging of Receivables Example

Again, suppose a business has accounts receivable of 50,000 due from customers on 45 day terms, and pledges the accounts receivable to raise additional funding. The financing company agrees to advance 85% (42,500) of the outstanding accounts for a 0.5% fee (250), and also charges interest on any advance at the rate of 8% on the outstanding advance balance. The remaining balance is to be paid in 45 days when they are collected from the customer.

The business records the original sale to the customer
Account Debit Credit
Accounts receivable 50,000
Revenue 50,000
The accounts receivable are pledged to the finance company
Account Debit Credit
Loan or note payable 42,500
Cash 42,000
Financing fee 500
Total 42,500 42,500

With pledging of receivables, the accounts receivable are not removed from the balance sheet and remain an asset of the business. Cash collected from the invoices is not specifically due to the finance company so the invoices remain on the customer accounts receivable account. The receipt of cash from the advance is then recorded as a loan or note payable and the fee is recorded as an expense.

Interest is now charged on any outstanding advance balance at the rate of 8%. In the above example at the end of the accounting period (month), the business would accrue an interest expense of 42,500 x 8%/12 = 283 in the usual manner.

Comparison of Receivables Financing Methods

To show the differences between the various methods of receivables financing, the summary chart below sets out a simplified balance sheet for each of the methods. For simplicity, fees are ignored, and it is assumed that a cash advance of 40,000 is made in each case against accounts receivable of 50,000.

Receivables Factoring, Assignment, and Pledging Comparison
Before Factoring Assignment Pledging
Cash 40,000 40,000 40,000
Accounts receivable 50,000 50,000
Accounts receivable – assigned 50,000
Due from factoring company 10,000
Total assets 50,000 50,000 90,000 90,000
Loan from finance company 40,000 40,000
Capital 50,000 50,000 50,000 50.000
Total liabilities and equity 50,000 50,000 90,000 90,000

Note on Terminology
*The term invoice discounting is used in the UK to refer to a type of receivables factoring in which the process remains confidential between the business and the factoring company, and the business retains the responsibility of collecting the outstanding accounts from customers.

Receivables Financing November 6th, 2016Team

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