Using Accounts Receivable for Financing

Accounts receivable financing can be defined as a method of asset financing wherein a company uses the money that is owed to it by customers, also known as receivables, as security for getting additional finances. The amount that the company receives in return for this is equivalent to the reduced value of the receivables. An important factor that determines the amount of finances received by the company is how old the receivables are. Receivables that are more recent will fetch the company a higher amount compared to older receivables. This method can be a good substitute for bank financing methods. There are two ways in which accounts receivable financing can be used by a company.

Pledging Accounts Receivable
Pledging refers to using accounts receivable by the company as a security for borrowing money to manage its finances. However, one thing that must be remembered in this case is that despite the lender holding the accounts receivable as collateral, it is the company’s responsibility to approach the customers to pay off the pending accounts. Lenders may not accept all accounts receivable as security for lending money. There is a tendency among lenders not to accept overdue accounts. Lenders may also not lend if they feel that the term for the accounts receivable is too long. Once the lender has decided on the accounts they will not accept, they fix the percentage of the value of the accounts on which they will lend. Such loans are taken mainly by small businesses and in case of a default, the company’s account receivables are possessed by the lender and they collect the debts on them from the customers.

Factoring Accounts Receivable
Under this method, a business sells its accounts receivable to a factoring company in exchange for finances. The business is paid an advance amount by the factoring company on the accounts receivable which may be around 70-90 per cent of the total worth of the receivables. A fee of about 2-3 per cent is charged by the factoring company and the rest of the amount is paid to the business once it has received the amount on the accounts receivable from the customers. Although factoring can be a costly method for financing, it can be helpful as it minimizes the risk of the firm borrowing the money.
Using the accounts receivable for financing can be a fruitful option, especially for a business that is small in size.

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