Accounts Receivable Financing Will Include A Firm Offering Debtors For Fast Expense But At A Discount To Book Worth

Article Written By: Ben Pate

Funds are advanced by a accounts receivable factoring firm to an operating business against its receivables balance. Factoring is, for the most part, structured as a purchase-and-sale transaction so that a trading business sells its asset based finance amount to a so-called factoring or factor firm. Ownership of the receivables balance of the trading business is legally transferred to the factor firm.

The sale is normally agreed at a discount price compared to the nominal receivables book value as recorded in the financial statements of the trading business. The business firm selling that asset receives an immediate cash payment.

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 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.

Another important issue centers on the risk of debtor defaults. Some factoring firms offer flexibility on this issue and can structure their transactions in one of two ways, depending on the preference of the business. These two alternatives are known as non-recourse factoring and without appeal factoring.

Non-recourse factoring involves non-payment risk being accepted by the factoring firm and agreeing it has no recourse back to the business if its default experience is worse than expected. Without appeal factoring is the opposite; non-payment risk is accepted by the business. Naturally, if the factor firm accepts default risk, the price it will offer for the receivables will be lower.

About the Author

The market for invoice financing is large. Analysts estimate the annual value of accounts receivable factoring transactions alone totals over $150 billion in the USA.

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