The term financing receivables is used to describe an arrangement whereby a business uses its receivables to gain immediate access to cash. Financing receivables usually fall into two broad categories, which involve either the sale of receivables or a secured loan.
Companies will oftentimes extend credit to customers, providing immediate access to the product or service and allowing customers to pay for it in the future. While extending credit to customers can help to increase sales, it can also limit the company’s access to the cash it may need to grow its business.
Companies that wish to gain near immediate access to the money tied up in accounts receivables have two options:
- Sale of Receivables: with this first option, the company removes a portion of its accounts receivable from its balance sheet, creating a virtual sale of this asset to a buyer that will subsequently collect the money owed from customers.
- Secured Loan: with this second option, the company uses the balance in accounts receivable as collateral for a loan. Accounts receivable remains on the balance sheet of the company / borrower as a current asset, while the lender now has a secured note receivable.
In either of the above options, the lender or buyer will take into account the quality of the company’s receivables. For example, the longer it takes a customer to repay the amount owed, the less likely it is the company will ever collect the money; these older receivables are less valuable. When a company purchases receivables, it takes this “aging” into account and applies a larger discount to the asset’s value. This is known as factoring.
Publicly-traded companies are required by federal laws under the jurisdiction of the Securities and Exchange Commission (SEC) to disclose certain operating and financial information on an ongoing basis. As part of its Form 10-K filing, companies must disclose all material financing receivables arrangements.
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