Is your Small Business in a tight cash situation?

How to Dispose of Accounts Receivable

Article written by EricBank

Many a small business has found itself in a cash crunch from time to time. This can be especially vexing for business-to-business (B2B) companies, which extend trade credit to other businesses and therefore depend on accounts receivable for payments -- a process that can take weeks or months. Retail businesses usually rely on credit card and cash purchases, which are normally not problematic as payment is immediate or prompt. But B2Bs might have A/R balances that represent a substantial part of working capital. In a crunch, a B2B has several options to quickly turn an A/R balance into cash.

Factoring

A bank or finance company that buys your A/R book is called a factor. The factor assumes title to the invoices in your A/R book when it buys it. In some contracts, you must guarantee that the factor receives full payment for all invoices -- this a contract with recourse. When the factor assumes all the risk of payment, it's called a non-recourse contract. Obviously, you receive less cash for a non-recourse contract. You usually receive a certain percentage of the A/R's book value and possibly a percentage of collections once they exceed the percentage you received. For instance, you might receive 80 percent of book value and 40 percent of all collections received after the factor has collected the 80 percent from your customers. You also might have to pay the factor a fee.

Auction

An online receivables exchange is a handy alternative to a standard factoring arrangement. The way it works is that you select some or all of your A/R invoices and list them on the exchange. Bidding then commences among financial institutions and banks, hopefully helping to boost the amount you'll receive for the invoices. The auction is pretty flexible, because you get to choose which invoices to unload and there aren't any long-term commitments. The risk is that the bid will be lower than the percentage you would have received from a straight-up factoring arrangement.

Pledging

 

Maybe you don't want to sell your A/R book, but still need some fast cash. Consider pledging the book as collateral for a loan from a bank or finance company. This is a recourse arrangement, but you retain title to the invoices. One good feature is that the process is invisible to your customers -- they continue to pay you, not some third party. In some cases, the lender might have you set up a lock box to receive the payments, but it will be in your name. Your balance sheet continues to list the pledged A/R balance as an asset, although you might have to add a footnote if you publish your financials.

Assignment

Assignment is a hybrid of pledging and factoring. The financial company or bank (the "assignee") pays you cash for the rights to your A/R collections. You use the A/R book as collateral for a promissory note that you sign with the assignee. It's still your job to collect your A/R invoices, but you forward the money to the assignee. The assignee has recourse in case any of the customers are deadbeats. The balance sheet requirements are similar to those for pledging, though you'll also have to show notes payable.