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Accounts Receivable Financing Can Involve A Firm Offering Debtors For Immediate Transaction But At A Discount To Book Cost
Accounts receivable financing is a flexible form of short term, asset-based commercial financing. Receivables factoring is a common form of this type of financing. In most cases accounts receivable factoring is structured as a sale transaction. It is not a debt or loan transaction. A trading business sells its accounts receivables amount to factoring or invoice discounter firm. This type of transaction may also be referred to as invoice factoring and is a form of asset securitization.
Factoring is, for the most part, structured as a purchase-and-sale transaction so that a trading business sells its accounts receivable financing 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 received by the trading business for its receivables is dependent on a range of variables. These include the average size and age of the outstanding invoices (or accounts receivable balance), the number of customers, their creditworthiness, and the average length of the normal payment cycle. The weighting placed in each of these varies from financier to financier.
A distinction exists between accounts receivable factoring and accounts receivable loans. The distinction hangs on ownership of the underlying receivables asset. An accounts receivable loan involves ownership of the receivables remaining with the business. An accounts receivable factoring transaction involves ownership of the receivables being assigned to the factoring firm.
Factoring firms adopt two alternative approaches to the risk of non-payment by debtors (debtor default). These two approaches are reflected in the transaction structure or documentation. Non-recourse sees the factoring firm take on all non-payment risk and no recourse for compensation from its customer, the trading business. Without appeal factoring involves the opposite situation, all debtor risk is carried by the trading business.
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.
The market for asset based finance is large. Analysts estimate the annual value of accounts receivable factoring transactions alone totals over $150 billion in the USA. Factor firms typically offer trading business between 60 to 90 percent of the nominal value of their receivables balance. The trading business usually pays the factor firm a monthly fee and also an interest charge based on the amount advanced.
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