The Definition of "Accounts Receivable Financing"

Businesses resort to accounts receivable financing to fund their operating activities until customers pay for goods or services. The practice is particularly common in industries where clients don't pay for merchandise on delivery but generally remit funds after 30, 60, 90 or 120 days, depending on agreed-upon credit terms or bank-financing agreements.

Definition

Accounts receivable financing means a financial institution agrees to give money to a business in exchange for the company's customer receivables. These are amounts the business expects to collect from clients when the receivables become due. The financial institution, or factor, advances funds to the company after verifying that its customers are creditworthy and can repay trade amounts at maturity. The factoring company also deducts a fee from the receivables amount for the service. "Accounts receivable financing" and "customer receivables factoring" are identical phrases.

Importance

By financing its customer receivables, a business takes the necessary steps to avoid financial hardship and cover a temporary liquidity shortfall. The company may do so if it needs money right away and customers wouldn't pay for goods on delivery, but within agreed-upon credit periods, which often run the gamut from a few days to a few months. In essence, factoring is a form of commercial lending. Accordingly, corporate management checks interest rates available for other short-term loans before financing receivables. For example, if banks charge 10 percent for short-term loans and factoring fees hover around eight percent, it makes more sense for top leadership to sell the receivables and receive cash upfront than borrowing to cover operating expenses.

Personnel Involvement

Various personnel help businesses cope with temporary cash problems and deal with the bewildering speed often associated with modern business. Most companies, especially large multinational firms, must process many transactions every day, find money to pay for business needs and record accurate revenue data. Professionals engaging in accounts receivable financing include accountants, corporate treasurers, investment analysts and budget supervisors. Other groups include cost controllers as well as sales and marketing specialists.

Process

Deciding whether to finance a company's receivables is a collective effort. Corporate treasurers evaluate, on a daily basis, how much money the firm needs to operate, as well as how much cash will come in. It the projected cash balance is negative, treasurers work in tandem with finance personnel to identify ways to raise additional funds without putting too much pressure on operating activities. They may decide to tap into the corporate cash reserve, apply for a short-term loan or finance accounts receivable. This option often depends on the company's funding needs and conditions on credit markets.

References

• The Free Dictionary by Farlex: Factoring (Finance)
• Carnegie Mellon University; Accounts Receivable Financing and Information Asymmetry; Hagit Levy; March 2010
• Murray State University: Pledging vs. Factoring of Accounts Receivable
• Murray State University: Pledging of Accounts Receivable
• "Fundamentals of Corporate Finance, 8th Edition"; The McGraw-Hill Companies; 2008