Account receivable financing - Financing Receivables

Account receivable financing is a powerful financial tool that allows businesses to convert their outstanding invoices into immediate cash. Instead of waiting for customers to pay, companies can leverage their receivables to secure working capital, improve cash flow, and fund operations or growth initiatives. This type of financing is crucial for businesses looking to bridge the gap between sales and payment collection.

What Are Receivables and How Are They Financed?

Receivables represent amounts owed to a business or individual for goods, services, facilities, rent, salary, or royalties. While typically associated with businesses, non-business entities can also have receivables. Financing against these account receivable financing allows you to access funds based on money that is due to you.

Common examples of receivables that can be financed include:

• Amounts due from traders or manufacturers for supplied materials.
• Payments for transport vehicles (e.g., buses, trucks, cars, airplanes, ships) sold on a hire purchase basis.
• Credit sales of goods for export.
• Payments for intellectual property like software, architectural designs, or brokerage services.
• Lease payments for machinery or vehicles.
• Rent from leased buildings, land, or commercial spaces.
• Royalties from granted rights, such as publishing a book or manufacturing and selling a drug.
• Personal loans repaid from future salaries.

To secure account receivable financing, lenders typically require a charge or hypothecation of the receivables. This legal arrangement grants the lender the right to collect or recover the receivables, either in the normal course of business or if the borrower defaults. For this charge to be effective and enforceable, the debtor must be notified of the arrangement and agree to make payments directly to the lender (the chargee/hypothecatee).

In cases with a few major debtors, it might be practical for debtors to issue checks directly to the lending institution's account for the borrower, ensuring direct realization of dues. If there are many debtors and the borrower has excellent credit, the borrower may collect the debts and then make payments to the lender from those collections.

How Do Lenders Monitor Receivable Financing?

As part of the financing agreement, borrowers are usually required to submit regular statements (e.g., weekly, bi-weekly, or monthly) detailing the receivables charged to the lender. Lenders may also visit the borrower's premises to verify the authenticity and accuracy of these statements by cross-referencing invoices and acknowledgments of indebtedness from debtors. It's also advisable for lenders to obtain direct confirmations of outstanding balances from major debtors.

Once a debtor is properly notified of the lender's interest in their outstanding dues, they are legally obligated to pay those debts directly to the lender if requested. Failure to do so can make the debtor liable to the lender. Courts have often upheld that a charge over receivables, combined with a Power of Attorney from the company owed the debts, constitutes an "equitable charge" that is legally enforceable.

What Percentage of Receivables Can Be Financed?

Lenders typically extend financing up to a certain percentage of the value of the receivables reported in the borrower's periodic statements. This "drawing power" varies based on the lender's policies, the quality of the receivables, and the borrower's creditworthiness.

Are There Different Types of Receivable Financing?

Financing against receivables is often combined with other forms of working capital finance, covering both inventory and receivables. This comprehensive approach ensures businesses have sufficient funds for their operational needs.

Some specific forms of receivable financing include:

• Factoring: This involves a lender purchasing invoices for supplies made, including those on credit. Factoring can be "with recourse" (meaning the borrower is still responsible if the debtor doesn't pay) or "without recourse" (where the lender assumes the credit risk).
• Forfaiting: This is a form of medium- to long-term financing, particularly used for international trade, where the buyer-debtor is located abroad.

Beyond traditional invoices, financing for significant assets like airplanes or ships can be structured as medium-term credit (repayable within three years) or long-term credit (repayable over five to ten years).

Who Qualifies for Receivable Financing?

A crucial precondition for a borrower to be eligible for account receivable financing is a very high credit rating. Lenders assess the borrower's financial stability and repayment history to mitigate risk.

What Are the Benefits for Lenders?

Lenders who hold a charge on receivables gain preference and priority as secured creditors. This means they have a stronger claim to the assets compared to unsecured creditors or a liquidator if the borrower faces financial distress. In the event of the borrower's default in repayment, the lender (chargee/hypothecatee) steps into the borrower's shoes and has the power to take direct legal action against defaulting debtors.