assignment of receivables without recourse

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What Is Without Recourse?

Understanding recourse, sales without recourse, without recourse in banking, what does it mean to assign without recourse, what does without recourse mean in real estate, how do i endorse a check without recourse.

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Without Recourse: Meaning, Example, Vs. With Recourse

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

"Without recourse" means that one party cannot obtain a judgment against, or reimbursement from, a defaulting or opposing party in a financial transaction. When the buyer of a  promissory note  or other negotiable instrument enters into a "no recourse" agreement, they assume the risk of default.

Key Takeaways

• Without recourse means that the buyer of a promissory note, or lender, assumes the risk of default.
• When a financial instrument contains the words "without recourse," the endorser is released from future claims.
• Sales agreements that are made without recourse create a caveat emptor situation.

Financing can be extended  with or without recourse . Under financing "with recourse," if the lender cannot collect on their payment from the party ultimately responsible for payment of the financial obligation, the lender can go back to the borrower to seek payment on the amount due. Recourse may allow the lender to seize not only pledged collateral, but also deposit accounts, and sources of income.

Conversely, "without recourse" financing means that the lender takes the risk of non-payment by the  obligor . The lender takes these risks directly and cannot seek payment or seize personal assets not specified in the debt contract .

"Without recourse" means without liability . All sales agreements entered into by a buyer and seller contain rights and responsibilities for both parties. A sale without recourse means the buyer accepts all risks associated with the purchase.

This often occurs when items are sold "as is" without any guarantees. The buyer has "no recourse" against the seller if the item does not work as expected and the seller is not obligated to compensate the buyer for any damages, defects, or performance issues.

A sale that is "with recourse" means that the seller bears responsibility for the sold asset if it turns out to be defective or does not perform as expected. The buyer has the right to seek recourse from the seller, who is often obligated to offer a replacement of equal value or provide a refund.

When a financial instrument contains the words "without recourse," the endorser is released from future claims. If a signed check includes "without recourse" the endorser is not subject to liability should the check bounce due to insufficient funds .

For example, assume Alice makes out a check to Bob. The payee, Bob, decides to pay off his debt to Maggie by endorsing the check, which involves writing his name on the back exactly as it appears on the front of the check. Once the back of the check is signed, it becomes negotiable and allows for the transfer of money ordered by the check. In addition, Bob adds “without recourse” on the back of the check. The endorser, Bob, will not assume any responsibility for paying the check if it is returned for insufficient funds. If Alice’s bank refuses to pay Maggie’s bank the check amount due to insufficient funds in Alice’s account, Maggie cannot demand payment from Bob.

A promissory note is a  debt instrument , like a mortgage loan, that contains a written promise by the buyer to pay the seller a definite sum of money. If the loan is secured "without recourse," the lender often uses the mortgaged property as collateral. The lender cannot hold the buyer liable, however, will instead recover the collateral.

Without recourse is evident in certificates of deposit (CDs) and securities where the seller is not required to indemnify the investor for any losses suffered, such as those caused by market fluctuations.

Loans are often sold or transferred among lenders. When a loan is assigned to a new lender, neither the borrower nor the new loan holder can hold the first loan originator liable for any loan-related issues.

Without recourse, or non-recourse debt is a type of loan secured by collateral, such as real estate cited on a mortgage loan. If the borrower defaults, the issuer can seize the collateral but cannot seek further compensation from the borrower.

Endorsing a check and adding "without recourse" to the signature means that the endorser assumes no responsibility if the check bounces for insufficient funds.

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Example Journal Entries for the Assignment of Trade Receivables

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Introduction, brief explanation of trade receivables.

In this article, we’ll cover example journal entries for the assignment of trade receivables. Trade receivables, often referred to as accounts receivable, represent the amounts owed to a business by its customers for goods or services delivered but not yet paid for. These receivables are considered current assets on a company’s balance sheet and play a crucial role in the business’s cash flow and liquidity. They arise from the credit sales extended to customers, allowing businesses to increase sales by offering flexible payment terms.

Importance of Managing Trade Receivables Effectively

Effective management of trade receivables is vital for maintaining a healthy cash flow and ensuring the financial stability of a business. Proper handling of receivables can lead to:

• Improved Cash Flow: Timely collection of receivables ensures that the business has sufficient cash to meet its operational needs and invest in growth opportunities.
• Minimized Bad Debts: By regularly monitoring and managing receivables, businesses can reduce the risk of non-payment and minimize bad debt expenses.
• Enhanced Customer Relationships: Efficient receivables management fosters positive relationships with customers by offering them flexible payment options while ensuring timely follow-ups.
• Accurate Financial Reporting: Proper accounting for receivables ensures accurate financial statements, which are essential for making informed business decisions and maintaining investor confidence.

Overview of Assigning Trade Receivables (Reasons, Benefits, and Risks)

Assigning trade receivables involves transferring the rights to collect receivables from customers to a third party, such as a financial institution or a factoring company. This process can be beneficial for businesses seeking immediate cash flow improvements or those looking to mitigate the risks associated with credit sales. There are two main types of assignments: with recourse and without recourse.

Reasons for Assigning Trade Receivables:

• Immediate Cash Flow: Businesses can quickly convert receivables into cash, providing immediate funds for operational needs or investment opportunities.
• Risk Mitigation: By transferring the collection risk to a third party, businesses can reduce their exposure to potential bad debts.
• Improved Financial Ratios: Assigning receivables can improve liquidity and leverage ratios, making the business more attractive to investors and lenders.

Benefits of Assigning Trade Receivables:

• Enhanced Liquidity: Immediate access to cash improves the company’s liquidity position, enabling it to meet short-term obligations and invest in growth.
• Streamlined Operations: Outsourcing the collection process allows businesses to focus on core activities rather than chasing payments.
• Credit Protection: In a non-recourse assignment, the risk of non-payment is transferred to the third party, protecting the assignor from credit losses.

Risks of Assigning Trade Receivables:

• Cost: The fees associated with assigning receivables can be significant, impacting the overall profitability of the business.
• Customer Relationships: Involving a third party in the collection process can potentially strain relationships with customers if not managed carefully.
• Reliance on Third Parties: Businesses become dependent on the third party’s efficiency and effectiveness in collecting receivables.

Understanding the dynamics of trade receivables and the implications of assigning them is essential for businesses to make informed decisions and maintain financial health.

Understanding Trade Receivables

Definition of trade receivables.

Trade receivables, also known as accounts receivable, represent the money owed to a business by its customers for products or services provided on credit. These receivables are recorded as current assets on the balance sheet, as they are expected to be converted into cash within a year. Trade receivables arise from the sale of goods or services where the payment is deferred, creating a formal obligation for the customer to pay the business at a later date.

The Role of Trade Receivables in Business Operations

Trade receivables play a critical role in the financial health and operational efficiency of a business. Their importance can be summarized as follows:

• Revenue Recognition: Trade receivables are a direct result of sales on credit, contributing to the revenue generation of a business.
• Cash Flow Management: Effective management of trade receivables ensures a steady inflow of cash, which is vital for meeting day-to-day operational expenses, repaying debts, and investing in growth opportunities.
• Customer Relationships: Offering credit terms can enhance customer satisfaction and loyalty, as it provides flexibility and convenience in payment, potentially leading to increased sales.
• Financial Planning: Accurate recording and monitoring of trade receivables help in forecasting cash flow and planning financial strategies accordingly.

Difference Between Trade Receivables and Other Types of Receivables

Trade receivables are a specific type of receivable that arises from the sale of goods or services on credit. However, businesses may also have other types of receivables, which differ in their origin and nature:

• Trade Receivables: These are amounts due from customers for goods or services sold on credit, typically short-term and unsecured.
• Notes Receivable: These are formal, written promises to pay a certain amount at a future date, often with interest. Notes receivable are usually more formalized and can be long-term, providing greater security for the lender.
• Other Receivables: This category includes various types of receivables not directly related to the core business operations, such as loans to employees, tax refunds, or interest receivable. These receivables may not be as closely tied to sales activities and can have different collection terms and risks.

Understanding the nuances between trade receivables and other types of receivables is essential for accurate financial reporting and effective management of a company’s assets. By distinguishing between these categories, businesses can better track and manage their receivables, ensuring a more accurate representation of their financial position.

Assignment of Trade Receivables

Definition and explanation of assigning trade receivables.

Assigning trade receivables involves transferring the rights to collect the receivables from the original holder (the assignor) to a third party (the assignee). This process allows businesses to convert their receivables into immediate cash, enhancing liquidity and improving cash flow management. The assignment can be done either as a sale of receivables or as a collateral for a loan.

In an assignment, the business still records the receivables on its balance sheet but reports the assignment as a separate liability or reduction in the value of the receivables, depending on the nature of the assignment. The key benefit of assigning trade receivables is that it allows businesses to access funds tied up in credit sales without waiting for customers to pay their invoices.

Types of Assignments

There are two main types of assignments: with recourse and without recourse.

Assignment with Recourse

In an assignment with recourse, the assignor retains the risk of non-payment by the debtor. This means that if the customer fails to pay the receivable, the assignor is obligated to reimburse the assignee. Assignments with recourse often have lower costs compared to non-recourse assignments because the risk remains with the assignor.

Journal Entry Example:

• When assigning the receivable:

Debit: Cash Debit: Loss on Sale of Receivables Credit: Accounts Receivable

If the receivable is not paid by the customer:

Debit: Accounts Receivable Credit: Cash

Assignment without Recourse

In an assignment without recourse, the risk of non-payment is transferred to the assignee. This means that if the customer fails to pay, the assignee bears the loss, not the assignor. Non-recourse assignments usually come at a higher cost due to the increased risk taken on by the assignee.

Common Scenarios Where Businesses Assign Trade Receivables

Assigning trade receivables can be a strategic move for businesses in various situations. Some common scenarios include:

• Improving Cash Flow: Businesses with seasonal sales patterns or those facing cash flow constraints may assign receivables to ensure a steady stream of funds.
• Financing Growth: Companies looking to finance expansion projects or new ventures might assign receivables to quickly raise capital without incurring additional debt.
• Risk Management: Firms seeking to reduce their exposure to credit risk may assign receivables, particularly in industries with high default rates or during economic downturns.
• Simplifying Collections: Businesses wanting to streamline their operations might assign receivables to a third party, outsourcing the collection process and reducing administrative burdens.
• Meeting Financial Covenants: Companies that need to comply with financial covenants set by lenders can use receivable assignments to improve their liquidity ratios and other financial metrics.

By understanding the various types of assignments and the scenarios in which they are used, businesses can make informed decisions to optimize their financial management and enhance operational efficiency.

Example Journal Entries

Detailed examples of journal entries for different scenarios.

Scenario: A company assigns $100,000 of trade receivables to a financial institution with recourse, receiving $95,000 in cash after a 5% service fee.

• Initial Assignment:

Debit: Cash $95,000 Debit: Loss on Sale of Receivables $5,000 Credit: Accounts Receivable $100,000

Explanation:

• Debit: Cash increases by $95,000, reflecting the cash received.
• Debit: Loss on Sale of Receivables records the 5% service fee ($5,000) as an expense.
• Credit: Accounts Receivable decreases by $100,000, indicating the assignment of the receivables.

Impact on Financial Statements:

• The company’s assets (cash) increase by $95,000.
• An expense of $5,000 is recognized, reducing net income.
• Accounts receivable decrease by $100,000.
• If the Receivable is Not Paid by the Customer:

Debit: Accounts Receivable $100,000 Credit: Cash $100,000

• Debit: Accounts Receivable reinstates the receivable as the company must now collect it.
• Credit: Cash decreases by $100,000, reflecting the reimbursement to the financial institution.
• Accounts receivable increase by $100,000.
• Cash decreases by $100,000.

Scenario: A company assigns $100,000 of trade receivables to a financial institution without recourse, receiving $90,000 in cash after a 10% service fee.

• Explanation: Debit: Cash increases by $90,000, reflecting the cash received. Debit: Loss on Sale of Receivables records the 10% service fee ($10,000) as an expense. Credit: Accounts Receivable decreases by $100,000, indicating the assignment of the receivables.
• Impact on Financial Statements: The company’s assets (cash) increase by $90,000. An expense of $10,000 is recognized, reducing net income. Accounts receivable decrease by $100,000.

Partial Assignment

Scenario: A company assigns $50,000 of its $200,000 trade receivables to a financial institution, receiving $47,500 in cash after a 5% service fee.

• Explanation: Debit: Cash increases by $47,500, reflecting the cash received. Debit: Loss on Sale of Receivables records the 5% service fee ($2,500) as an expense. Credit: Accounts Receivable decreases by $50,000, indicating the partial assignment of receivables.
• Impact on Financial Statements: The company’s assets (cash) increase by $47,500. An expense of $2,500 is recognized, reducing net income. Accounts receivable decrease by $50,000.

Factoring vs. Assignment

Factoring Example:

Scenario: A company sells $100,000 of trade receivables to a factoring company, receiving $90,000 in cash after a 10% discount.

• Explanation: Debit: Cash increases by $90,000, reflecting the cash received. Debit: Factoring Expense records the 10% discount ($10,000) as an expense. Credit: Accounts Receivable decreases by $100,000, indicating the sale of receivables.

Assignment Example:

Scenario: A company assigns $100,000 of trade receivables to a bank as collateral for a $90,000 loan.

• Explanation:Debit: Cash increases by $90,000, reflecting the loan received. Credit: Loan Payable records the liability for the loan.
• Impact on Financial Statements: The company’s assets (cash) increase by $90,000. A liability (loan payable) of $90,000 is recognized. Accounts receivable remain on the balance sheet but are disclosed as collateral in the notes to the financial statements.

By understanding these journal entries, businesses can accurately record the financial transactions associated with different types of assignments and factoring of trade receivables, ensuring precise financial reporting and effective management of receivables.

Practical Applications and Implications

How businesses use assignments to manage cash flow.

Assigning trade receivables is a strategic financial tool used by businesses to manage cash flow more effectively. By converting receivables into immediate cash, companies can:

• Maintain Operational Liquidity: Businesses often face timing differences between cash inflows and outflows. Assigning receivables ensures that companies have sufficient cash to meet operational expenses such as payroll, inventory purchases, and utility bills.
• Invest in Growth Opportunities: Immediate access to cash allows businesses to invest in growth opportunities such as expanding production capacity, entering new markets, or developing new products.
• Reduce Borrowing Costs: By using assigned receivables to generate cash, companies can reduce their reliance on traditional loans, which might come with higher interest rates and more stringent repayment terms.
• Manage Seasonal Fluctuations: Businesses with seasonal sales patterns can use receivable assignments to smooth out cash flow throughout the year, ensuring they have funds during off-peak periods.

Impact on Financial Health and Creditworthiness

The assignment of trade receivables can have significant implications for a business’s financial health and creditworthiness:

• Improved Liquidity Ratios: Assigning receivables increases the company’s cash reserves, improving liquidity ratios such as the current ratio and quick ratio. These enhanced ratios signal better short-term financial health to investors and creditors.
• Enhanced Creditworthiness: Consistent management of cash flow through receivable assignments can improve a company’s creditworthiness. Lenders and suppliers may view the business as more financially stable and less risky.
• Balance Sheet Implications: While assigned receivables may still appear on the balance sheet (depending on the assignment type), the associated liabilities or reductions are also recorded. This transparency helps maintain accurate financial reporting.
• Expense Recognition: Fees and discounts associated with assigning receivables are recorded as expenses, which can impact net income. However, the benefits of improved cash flow and liquidity often outweigh these costs.

Legal Considerations and Documentation Required

Assigning trade receivables involves several legal considerations and requires thorough documentation to protect the interests of both the assignor and the assignee:

• Assignment Agreement: A formal agreement outlining the terms of the assignment is essential. This document should specify the receivables being assigned, the rights and obligations of each party, the fees or discounts applied, and the recourse terms if applicable.
• Notification of Debtors: In many cases, the debtor (customer) must be notified of the assignment. This notification ensures that payments are directed to the assignee and clarifies the debtor’s obligations.
• Compliance with Regulations: Businesses must comply with relevant laws and regulations governing the assignment of receivables. This includes adhering to accounting standards (e.g., GAAP or IFRS) and any industry-specific regulations.
• Protection of Interests: Both parties must ensure that their interests are protected in the event of non-payment. This might include specifying procedures for handling disputed receivables and detailing the steps to be taken if the assignor defaults on their obligations.
• Confidentiality Clauses: Assignment agreements often include confidentiality clauses to protect sensitive financial information about the receivables and the involved parties.

By understanding and addressing these practical applications, financial impacts, and legal requirements, businesses can effectively utilize the assignment of trade receivables to manage cash flow, enhance financial stability, and maintain compliance with legal standards.

Common Mistakes and How to Avoid Them

Frequent errors in recording journal entries for assignments.

• Error: Misclassifying assigned receivables as still fully owned by the business, leading to inaccuracies in financial statements.
• Correction: Ensure assigned receivables are properly recorded as either a sale or collateral, reflecting the true nature of the transaction.
• Error: Failing to account for service fees, discounts, or losses incurred during the assignment process.
• Correction: Always include any associated fees or losses as expenses in the journal entries to accurately reflect the cost of the assignment.
• Error: Not recording potential liabilities in assignments with recourse, which can misrepresent the company’s financial obligations.
• Correction: Record a liability for the potential repayment obligation in assignments with recourse to ensure all financial responsibilities are accurately documented.
• Error: Recording assigned receivables without removing them from the accounts receivable balance, resulting in double-counting.
• Correction: Ensure that the assigned receivables are deducted from the accounts receivable account to prevent inflation of asset values.
• Error: Failing to notify debtors of the assignment, leading to payment confusion and potential collection issues.
• Correction: Always notify debtors promptly and clearly about the assignment to ensure payments are directed correctly to the assignee.

Tips for Accurate Record-Keeping and Compliance with Accounting Standards

• Keep comprehensive records of all assignment agreements, including terms, conditions, and notifications sent to debtors. This documentation will support accurate journal entries and compliance with legal requirements.
• Conduct frequent reconciliations of assigned receivables to ensure that the recorded amounts match the actual assignments and collections. This practice helps identify and correct discrepancies promptly.
• Follow relevant accounting standards such as GAAP or IFRS when recording assignments. These standards provide guidelines on how to treat assigned receivables, ensuring consistency and accuracy in financial reporting.
• Establish strong internal controls over the assignment process to prevent errors and fraud. Controls should include authorization procedures, segregation of duties, and regular audits.
• Utilize accounting software that supports receivables management and assignment transactions. Software can automate calculations, track assignments, and generate accurate journal entries, reducing the risk of human error.
• Ensure that accounting personnel are well-trained in handling assignments of trade receivables. Regular training sessions and updates on new standards or practices can help maintain accuracy and compliance.
• When in doubt, seek advice from financial experts or auditors. Professional guidance can help navigate complex transactions and ensure that all assignments are recorded correctly and in compliance with accounting standards.

By being aware of common mistakes and following these tips for accurate record-keeping, businesses can avoid errors in recording journal entries for assignments of trade receivables and ensure compliance with accounting standards. This approach enhances the reliability of financial statements and supports effective financial management.

Case Studies and Real-World Examples

Case study of a business using assignment of trade receivables.

Company Background: XYZ Manufacturing is a mid-sized company that produces industrial machinery. The company experiences seasonal fluctuations in sales, with peak periods in the spring and fall. To manage cash flow during the slower winter months, XYZ Manufacturing decided to assign a portion of its trade receivables to a financial institution.

Scenario: In November, XYZ Manufacturing had $500,000 in outstanding trade receivables. To ensure sufficient cash flow for the upcoming winter, the company assigned $300,000 of these receivables to a financial institution with recourse. The institution provided $285,000 in cash upfront, after a 5% service fee ($15,000).

Journal Entries:

Debit: Cash $285,000 Debit: Loss on Sale of Receivables $15,000 Credit: Accounts Receivable $300,000

• Assume a customer defaults on a $50,000 receivable. Debit: Accounts Receivable $50,000 Credit: Cash $50,000

Analysis of the Financial Impact and Outcomes

Improved Cash Flow: By assigning $300,000 of trade receivables, XYZ Manufacturing received $285,000 in cash. This immediate infusion of funds allowed the company to cover operational expenses, such as payroll and supplier payments, during the slower winter months. The improved cash flow also enabled the company to take advantage of early payment discounts from suppliers, further reducing costs.

• Balance Sheet: The accounts receivable balance decreased by $300,000, reflecting the assigned receivables. The cash balance increased by $285,000, and an expense of $15,000 was recognized as a loss on the sale of receivables. If any customer defaulted, the company recorded the defaulted amount as a receivable again and reduced its cash balance by the same amount.
• Income Statement: The $15,000 service fee was recorded as an expense, reducing the company’s net income for the period. However, the improved cash flow and ability to capitalize on early payment discounts provided a net positive effect overall.

Creditworthiness and Financial Health:

• Creditworthiness: Assigning receivables with recourse meant XYZ Manufacturing retained some risk of non-payment. Despite this, the company’s creditworthiness improved due to better liquidity and a more favorable cash position. Lenders and suppliers viewed the company as more financially stable, leading to better credit terms and reduced borrowing costs.
• Financial Health: The immediate access to cash allowed XYZ Manufacturing to maintain smooth operations and avoid the financial strain typically associated with seasonal fluctuations. The company could also invest in maintenance and minor capital expenditures during the off-peak period, ensuring readiness for the next peak season.

Lessons Learned:

• Effective Cash Flow Management: The case of XYZ Manufacturing highlights the importance of using trade receivables assignment as a tool for managing cash flow, particularly for businesses with seasonal sales patterns.
• Cost-Benefit Analysis: Companies must weigh the costs of assigning receivables, such as service fees, against the benefits of improved liquidity and financial stability.
• Risk Management: Even with recourse assignments, businesses can manage the risk of customer defaults through careful credit evaluations and maintaining a diversified customer base.

The case of XYZ Manufacturing demonstrates how the strategic use of trade receivables assignments can enhance a company’s financial stability, improve cash flow, and support sustained growth, especially in the face of seasonal sales fluctuations.

Summary of Key Points

In this article, we explored the concept of trade receivables and the practice of assigning them to manage cash flow. We covered the definition and role of trade receivables in business operations, the different types of assignments (with recourse and without recourse), and provided detailed examples of journal entries for various scenarios. We also discussed the practical applications and implications of assigning trade receivables, including their impact on financial health and creditworthiness, and the legal considerations involved. Additionally, we highlighted common mistakes in recording journal entries and provided tips for accurate record-keeping and compliance with accounting standards. Finally, we examined a real-world case study to illustrate the benefits and challenges of trade receivables assignments.

Importance of Accurate Journal Entries

Accurate journal entries are crucial for maintaining the integrity of financial records and ensuring compliance with accounting standards. Properly recorded entries provide a clear and accurate picture of a company’s financial position, which is essential for making informed business decisions. In the context of trade receivables assignments, accurate journal entries help businesses track their receivables, manage cash flow effectively, and ensure transparency in financial reporting. Mistakes in recording assignments can lead to financial discrepancies, misrepresentation of assets and liabilities, and potential legal issues.

Final Thoughts on Best Practices for Managing Trade Receivables Assignments

To effectively manage trade receivables assignments, businesses should adopt the following best practices:

• Thorough Documentation: Maintain detailed records of all assignment agreements, including terms, conditions, and notifications to debtors. This ensures transparency and supports accurate financial reporting.
• Regular Reconciliation: Conduct frequent reconciliations of assigned receivables to identify and correct discrepancies promptly, ensuring the accuracy of financial statements.
• Compliance with Standards: Adhere to relevant accounting standards (GAAP or IFRS) when recording assignments. These standards provide guidelines on how to treat assigned receivables consistently and accurately.
• Strong Internal Controls: Implement robust internal controls over the assignment process to prevent errors and fraud. This includes authorization procedures, segregation of duties, and regular audits.
• Use of Technology: Leverage accounting software that supports receivables management and assignment transactions. Automation can reduce the risk of human error and streamline the recording process.
• Training and Education: Ensure that accounting personnel are well-trained in handling assignments of trade receivables. Regular training sessions and updates on new standards or practices help maintain accuracy and compliance.
• Professional Guidance: Seek advice from financial experts or auditors when dealing with complex transactions. Professional guidance can help navigate the intricacies of receivables assignments and ensure proper recording.

By following these best practices, businesses can effectively manage the assignment of trade receivables, optimize their financial health, and maintain accurate and compliant financial records. This strategic approach supports sustainable growth and enhances overall financial stability.

Additional Resources and References

• Website: FASB
• Description: Provides information on accounting standards and updates for generally accepted accounting principles (GAAP) in the United States.
• Website: IFRS
• Description: Offers guidelines and standards for international financial reporting, including those relevant to trade receivables.
• Website: AICPA
• Description: A resource for accounting professionals providing guidance, standards, and best practices in accounting.
• Website: CFI
• Description: Provides courses and resources on financial analysis, accounting, and corporate finance, including trade receivables management.
• Website: Investopedia
• Description: Offers comprehensive articles and definitions related to finance and accounting, including trade receivables and assignments.

Glossary of Terms Used in the Article

• Amounts owed to a business by its customers for goods or services delivered on credit.
• The transfer of rights to collect receivables from the assignor (the business) to the assignee (a third party).
• A type of assignment where the assignor retains the risk of non-payment by the debtor.
• A type of assignment where the risk of non-payment is transferred to the assignee.
• The sale of receivables to a third party (factor) at a discount in exchange for immediate cash.
• An asset pledged as security for a loan, which can be forfeited in case of default.
• The ability of a business to meet its short-term obligations using its available assets.
• Assets that are expected to be converted into cash within one year, such as accounts receivable.
• An expense recorded when receivables are sold or assigned at a value lower than their book value.
• A fee charged by the assignee for the assignment of receivables, usually a percentage of the assigned amount.
• Metrics used to evaluate the financial health of a business, such as liquidity ratios and leverage ratios.
• The process of ensuring that two sets of records (e.g., bank statements and accounting records) are in agreement.
• Procedures and policies implemented by a business to ensure the integrity of financial and accounting information.

By consulting these additional resources and familiarizing yourself with the glossary of terms, you can gain a deeper understanding of the assignment of trade receivables and the associated accounting practices.

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The Difference Between Assignment of Receivables & Factoring of Receivables

You can raise cash fast by assigning your business accounts receivables or factoring your receivables. Assigning and factoring accounts receivables are popular because they provide off-balance sheet financing. The transaction normally does not appear in your financial statements and your customers may never know their accounts were assigned or factored. However, the differences between assigning and factoring receivables can impact your future cash flows and profits.

How Receivables Assignment Works

Assigning your accounts receivables means that you use them as collateral for a secured loan. The financial institution, such as a bank or loan company, analyzes the accounts receivable aging report. For each invoice that qualifies, you will likely receive 70 to 90 percent of the outstanding balance in cash, according to All Business. Depending on the lender, you may have to assign all your receivables or specific receivables to secure the loan. Once you have repaid the loan, you can use the accounts as collateral for a new loan.

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Using your receivables as collateral lets you retain ownership of the accounts as long as you make your payments on time, says Accounting Coach. Since the lender deals directly with you, your customers never know that you have borrowed against their outstanding accounts. However, lenders charge high fees and interest on an assignment of accounts receivable loan. A loan made with recourse means that you still are responsible for repaying the loan if your customer defaults on their payments. You will lose ownership of your accounts if you do not repay the loan per the agreement terms.

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How Factoring Receivables Works

When you factor your accounts receivable, you sell them to a financial institution or a company that specializes in purchasing accounts receivables. The factor analyzes your accounts receivable aging report to see which accounts meet their purchase criteria. Some factors will not purchase receivables that are delinquent 45 days or longer. Factors pay anywhere from 65 percent to 90 percent of an invoice's value. Once you factor an account, the factor takes ownership of the invoices.

Factoring Strengths and Weaknesses

Factoring your accounts receivables gives you instant cash and puts the burden of collecting payment from slow or non-paying customers on the factor. If you sell the accounts without recourse, the factor cannot look to you for payment should your former customers default on the payments. On the other hand, factoring your receivables could result in your losing customers if they assume you sold their accounts because of financial problems. In addition, factoring receivables is expensive. Factors charge high fees and may retain recourse rights while paying you a fraction of your receivables' full value.

• All Business: The Difference Between Factoring and Accounts Receivable Financing

Accounts Receivable Assignment: Key Concepts and Business Impact

Explore the essential concepts and business impact of accounts receivable assignment, including cash flow effects and advanced techniques.

Efficient management of accounts receivable is crucial for maintaining a healthy cash flow in any business. Assigning these receivables can be an effective strategy to optimize liquidity and reduce financial risk.

Understanding the implications of this practice helps businesses make informed decisions that align with their financial goals.

Key Concepts of Accounts Receivable Assignment

Accounts receivable assignment involves transferring the rights to collect receivables from a business to a third party, often a financial institution. This practice is typically used to secure immediate cash flow, allowing businesses to meet short-term obligations without waiting for customer payments. The third party, known as the assignee, then assumes the responsibility of collecting the receivables.

One of the primary concepts in accounts receivable assignment is the distinction between recourse and non-recourse agreements. In a recourse agreement, the business retains some liability if the receivables are not collected, meaning they may need to compensate the assignee for any uncollected amounts. Conversely, a non-recourse agreement transfers the full risk of non-payment to the assignee, providing the business with greater financial security but often at a higher cost.

Another important aspect is the discount rate applied by the assignee. This rate reflects the cost of the service and the perceived risk associated with the receivables. Factors influencing the discount rate include the creditworthiness of the customers, the average collection period, and the overall economic environment. Businesses must carefully evaluate these rates to ensure that the benefits of immediate cash flow outweigh the costs.

Impact on Cash Flow

The assignment of accounts receivable can significantly influence a company’s cash flow dynamics. By converting receivables into immediate cash, businesses can bridge the gap between sales and actual cash inflows. This immediate liquidity can be particularly beneficial for companies facing seasonal fluctuations or those in industries with extended payment terms. For instance, a manufacturing firm might use receivable assignment to ensure it has the necessary funds to purchase raw materials, even if its customers take months to pay their invoices.

Moreover, the infusion of cash from receivable assignments can enable businesses to capitalize on growth opportunities. With more liquid assets on hand, companies can invest in new projects, expand operations, or take advantage of bulk purchasing discounts. This proactive approach to cash management can lead to increased profitability and a stronger market position. For example, a retail business might use the funds from assigned receivables to open new store locations, thereby increasing its market reach and revenue potential.

However, it’s important to recognize that while receivable assignment can provide immediate financial relief, it also comes with costs. The discount rate applied by the assignee reduces the total amount of cash received compared to the face value of the receivables. This reduction must be carefully weighed against the benefits of improved cash flow. Additionally, businesses must consider the potential impact on customer relationships, as the assignee will now be responsible for collections. Ensuring that the assignee maintains a professional and courteous approach is essential to preserving customer goodwill.

Accounting Treatment and Reporting

When it comes to the accounting treatment and reporting of accounts receivable assignments, businesses must adhere to specific guidelines to ensure accurate financial statements. The first step involves recognizing the assignment transaction in the accounting records. This typically requires debiting a cash account to reflect the immediate influx of funds and crediting the accounts receivable account to remove the assigned receivables from the company’s books. The difference between the receivables’ face value and the cash received, often due to the discount rate, is recorded as a financing expense or loss.

Proper disclosure is another critical aspect of accounting for receivable assignments. Financial statements must clearly indicate the nature and extent of the receivables assigned, including any recourse obligations if applicable. This transparency helps stakeholders understand the company’s financial position and the potential risks associated with the assigned receivables. For instance, notes to the financial statements should detail the terms of the assignment agreement, the discount rate applied, and any contingent liabilities that may arise from recourse provisions.

Additionally, businesses must consider the impact of receivable assignments on their financial ratios. Metrics such as the current ratio, quick ratio, and accounts receivable turnover can be significantly affected by the removal of receivables from the balance sheet. Analysts and investors often scrutinize these ratios to assess a company’s liquidity and operational efficiency. Therefore, it is essential to provide context and explanations for any substantial changes in these metrics due to receivable assignments.

Advanced Techniques in Receivable Assignment

Advanced techniques in receivable assignment can offer businesses more sophisticated ways to manage their cash flow and financial risk. One such technique is the use of securitization, where receivables are pooled together and sold as securities to investors. This method not only provides immediate liquidity but also diversifies the risk among multiple investors, making it an attractive option for companies with large volumes of receivables. Securitization can be particularly beneficial for industries like telecommunications or utilities, where customer bases are extensive and receivables are substantial.

Another advanced approach is dynamic discounting, which allows businesses to offer early payment discounts to their customers in exchange for quicker cash inflows. Unlike traditional discounting, dynamic discounting uses a flexible rate that can change based on the timing of the payment. This technique leverages technology platforms to automate and optimize the discounting process, ensuring that businesses can maximize their cash flow without sacrificing too much revenue. For example, a software company might use dynamic discounting to encourage its clients to pay invoices within 10 days instead of the standard 30, thereby improving its liquidity.

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Assignment of Accounts Receivable – Trap for the Unwary

By  Steven A. Jacobson

Most businesses are familiar with the mechanics of an assignment of accounts receivable. A party seeking capital assigns its accounts receivable to a financing or factoring company that advances that party a stipulated percentage of the face amount of the receivables.

The factoring company, in turn, sends a notice of assignment of accounts receivable to the party obligated to pay the factoring company’s assignee, i.e. the account debtor. While fairly straightforward, this three-party arrangement has one potential trap for account debtors.

Most account debtors know that once they receive a notice of assignment of accounts receivable, they are obligated to commence payments to the factoring company. Continued payments to the assignee do not relieve the account debtor from its obligation to pay the factoring company.

It is not uncommon for a notice of assignment of accounts receivable to contain seemingly innocuous and boilerplate language along the following lines:

Please make the proper notations on your ledger and acknowledge this letter and that invoices are not subject to any claims or defenses you may have against the assignee.

Typically, the notice of assignment of accounts receivable is directed to an accounting department and is signed, acknowledged and returned to the factoring company without consideration of the waiver of defenses languages.

Even though a party may have a valid defense to payment to its assignee, it still must pay the face amount of the receivable to the factoring company if it has signed a waiver. In many cases, this will result in a party paying twice – once to the factoring company and once to have, for example, shoddy workmanship repaired or defective goods replaced. Despite the harsh result caused by an oftentimes inadvertent waiver agreement, the Uniform Commercial Code validates these provisions with limited exceptions. Accordingly, some procedures should be put in place to require a review of any notice of assignment of accounts receivable to make sure that an account debtor preserves its rights and defenses.

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Home > Accounts Receivable > Receivables Financing

Receivables Financing

Receivables financing is a term used to refer to the process of a business raising additional funding using the value of its balance sheet accounts receivable , which represent amounts owed by customers for goods and services sold to them on credit terms.

Factoring Receivables

Invoice factoring means that the accounts receivable are sold at a discount to a factoring company for cash. In return for a fee, the factoring company undertakes to collect the accounts receivable from the customer and to advance a percentage of the face value of the outstanding amounts, with the remaining balance paid when the amounts have been collected from the customer.

Receivables Financing – Factoring of Receivables Example

Consider an example, suppose a business has accounts receivable of 50,000 due from customers on 45 day terms, and uses invoice factoring to raise additional funding. The factoring company agrees to purchase the outstanding accounts for a 5% discount fee (2,500), and also offers to advance the business 85% (42,500) of the face value of the accounts receivable, with the balance to be paid in 45 days when they are collected from the customer.

The main receivables financing journals are shown below. Additional journals relating to factoring can be found at our Factoring Accounts Receivable Journal Entries Reference.

The journals above refer to non-recourse factoring where the factoring company accepts full responsibility for the accounts receivable and their collection and cannot go back (has no recourse) to the business in the event of bad debts occurring. Alternative forms of factoring known as with-recourse factoring are available in which the business retains the risk of bad debts.

Assignment of Receivables

The second form of receivables financing is referred to as an assignment of receivables. Unlike factoring, in assignment of receivables, the outstanding invoices are not sold, but are assigned to a finance company. The assignment agreement effectively gives the finance company the right to receive the cash flows from specific customer invoices, and provides collateral against which, in return for a fee and interest, the financing company makes a loan to the business.

As the accounts receivable are not sold, they are not removed from the balance sheet of the business, and any cash advance received by the business becomes a loan or note payable from the financing company.

Receivables Financing – Assignment of Receivables Example

Consider an example, suppose a business has accounts receivable of 50,000 due from customers on 45 day terms, and uses assignment of receivables to raise additional funding. The financing company agrees to advance 85% (42,500) of the outstanding accounts for a 1% fee (500), and also charges interest on any advance at the rate of 10% on the outstanding advance balance. The remaining balance is to be paid in 45 days when they are collected from the customer.

The main receivables financing relating the assignment of accounts receivable are shown below. Additional journals relating to assignments can be found at our Assignment of Accounts Receivable Journal Entries Reference.

The receivables financing journals would be as follows:

With the assignment of receivables, the accounts receivable are not removed from the balance sheet but are transferred to a separate account called Accounts receivable assigned, in order that cash received from the customers can be allocated to the assigned invoices and repayment made to the finance company. The receipt of cash from the advance is then recorded as a loan or note payable and the fee is recorded as an expense.

Interest is now charged on any outstanding advance balance at the rate of 10%. In the above example at the end of the accounting period (month), the business would accrue an interest expense of 42,500 x 10%/12 = 354 in the usual manner.

Pledging Accounts Receivable

The final method of receivables financing is called pledging. When accounts receivable are pledged, the asset is simply used as collateral for a loan. The finance company does not have the right to cash flows from specific invoices, it simply has the right to use the accounts receivable as security in the event that the terms of the loan are not adhered to.

Receivables Financing – Pledging of Receivables Example

Again, suppose a business has accounts receivable of 50,000 due from customers on 45 day terms, and pledges the accounts receivable to raise additional funding. The financing company agrees to advance 85% (42,500) of the outstanding accounts for a 0.5% fee (250), and also charges interest on any advance at the rate of 8% on the outstanding advance balance. The remaining balance is to be paid in 45 days when they are collected from the customer.

With pledging of receivables, the accounts receivable are not removed from the balance sheet and remain an asset of the business. Cash collected from the invoices is not specifically due to the finance company so the invoices remain on the customer accounts receivable account. The receipt of cash from the advance is then recorded as a loan or note payable and the fee is recorded as an expense.

Interest is now charged on any outstanding advance balance at the rate of 8%. In the above example at the end of the accounting period (month), the business would accrue an interest expense of 42,500 x 8%/12 = 283 in the usual manner.

Comparison of Receivables Financing Methods

To show the differences between the various methods of receivables financing, the summary chart below sets out a simplified balance sheet for each of the methods. For simplicity, fees are ignored, and it is assumed that a cash advance of 40,000 is made in each case against accounts receivable of 50,000.

Note on Terminology *The term invoice discounting is used in the UK to refer to a type of receivables factoring in which the process remains confidential between the business and the factoring company, and the business retains the responsibility of collecting the outstanding accounts from customers.

About the Author

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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What is Factoring Accounts Receivables without Recourse?

For businesses that need liquidity and already have some sales and revenue momentum, factoring can be a great option.

Factoring of accounts receivable lets such businesses sell their invoices in exchange for immediate cash.

However, there are variations on factoring that vary the balance of risk between the client and the financier known as non-recourse and recourse accounts receivable financing.

With factoring accounts receivables without recourse, the factoring company assumes the credit risk on invoices when there’s non-payment because of the debtor’s insolvency, effectively insulating the client from this credit risk. For instance, if the client had an invoice for Best Buy and the factor provided financing against it on a non-recourse basis, then the factor assumes the risk.

That means if Best Buy files for bankruptcy, the factor loses the advance given to the client against the invoice rather than the client.

That’s a major reason why non-recourse factoring is an attractive option — it offers a level of credit protection. That can be especially critical if the client doesn’t have a great sense of the credit profile or risk of default of their customers.

It also saves the client the expense of seeking and paying for separate credit insurance on accounts receivables .

In this sense, with non-recourse factoring, the factor functions a bit like an outsourced credit department. When a client is looking to add a customer or sell more to an existing customer, it can check with the factor to see how much risk the factor is willing to take on that particular account. The client can use that information to inform its ongoing business decisions including how much business to carry out with that customer.

Such credit assessments can be crucial during financial crises or other times of financial upheaval. The financier is likely to have better information on the credit-worthiness of partners and should be seen as a valuable resource.

Like accounts receivable financing in general, the idea behind non-recourse factoring is that the client can focus on their core business instead of getting mired in the specifics of credit underwriting.

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What is Accounts Receivable Factoring?

How does accounts receivable factoring work, accounts receivable factoring vs. traditional operating line of credit, types of accounts receivable factoring, what types of businesses employ a/r factoring, more resources, accounts receivable factoring.

A form of short term financing available to business borrowers that sell on credit terms

Accounts receivable (A/R) factoring, often referred to as invoice discounting, is a type of short-term debt financing used by some business borrowers. The transaction takes place between a business (the borrower) and a lender (often a factoring company as opposed to a traditional commercial bank).

Factoring is only available as a funding source for companies that sell on credit terms, meaning that a borrower (the vendor) sells a good (or service), generating an invoice to its buyer for payment at a later date (terms may be 30, 45, or 60+ days). This expected future payment sits as an account receivable (a current asset ) on the vendor’s balance sheet.

A management team may choose to sell or assign this account receivable (or a specific invoice) to a factoring company at a discount to its face value in exchange for cash. The transaction permits the borrower to have cash today instead of waiting for the payment terms to be settled in the future.

Aside from the advantage of getting cash upfront, accounts receivable factoring is also commonly employed as a strategy to transfer payment risk to another party (in this case, the factoring company).

Key Takeaways

• Accounts receivable factoring is a source of debt financing available to businesses that sell on credit terms.
• The borrower assigns or sells its accounts receivable (or specific invoices) in exchange for cash today.
• A/R factoring is more expensive than a traditional bank line of credit but offers higher advance rates and greater flexibility around the uses of the loan proceeds.

A borrower’s management team assigns or sells the account receivable at a discount to its face value. The cash amount is expressed in percentage terms and is referred to as the “ advance rate .”

An advance rate can be thought of as a “loan-to-value” and it’s derived in a similar way to how a “borrowing base” or a “margin rate” might be calculated on an operating line of credit by a more traditional commercial lender.

A 90% advance rate on a $100,000 invoice would mean the factoring company wires the vendor $90,000 (90%) today, then remits the difference (less its interest charge) upon collection of the invoice from the vendor’s customer at the end of the invoice period.

Both A/R factoring and operating lines are considered forms of post-receivable financing, meaning an invoice has been generated (as opposed to Purchase Order Financing, which is pre-receivable). Assuming a commercial borrower qualifies for both, why might management choose one over the other?

There are advantages and disadvantages to both, best illustrated when measured against the following dimensions:

Interest rate

Rates can vary considerably based on a borrower’s risk, but in general, an operating line of credit will cost between 1% and 3.5% over the lender’s “Base Rate” (like bank prime), meaning an all-in annual interest rate of ~4% to ~9% depending on the jurisdiction and the rate environment. Factoring, on the other hand, will often cost 1.5%-3% per month (for an annualized rate of 20%-45%).

Duration of the exposure

While subject to annual reviews and margining requirements, a bank operating line is usually extended to revolve on an ongoing basis, as long as the lender can remain comfortable with the borrower’s risk profile. A/R factoring exposure generally only lasts as long as the vendor’s payment terms with its buyer (usually 30-90 days).

Loan-to-value (LTV)

A bank line of credit will generally advance up to 75% of good accounts receivable (meaning under some aging limit–usually 60 or 90 days). Many factoring companies will offer an advance rate of 75-90% of an invoice’s face value. This higher advance rate is considered attractive by many borrowers and might justify the higher cost.

Purpose of loan proceeds

A bank’s line of credit is used for “general working capital” support. This means it bridges a borrower’s working capital funding gap; it would usually be frowned upon (or even restricted) to use the proceeds to fund a dividend, for example.

Factoring, on the other hand, often has very few restrictions on the uses of loan proceeds. This flexibility is another reason many borrowers might be willing to pay a premium.

Broadly speaking, accounts receivable factoring can be categorized as follows:

1. Recourse vs. Non-Recourse Factoring

Recourse means that should a borrower’s customer not pay, the factoring company will retain “recourse” over the borrower (the vendor), meaning they can demand repayment. Non-recourse factoring means that the factoring company is out of pocket should the vendor’s buyer not settle its invoice.

2. Notification vs. Non-Notification

In a notification deal, the borrower’s buyer would be notified of the transaction, meaning that the company’s payable team would be contacted with new payment instructions by the factoring company. In a non -notification deal, the buyer is completely unaware of the vendor’s financing arrangement with the factoring company.

3. Regular vs. “Spot”

In a spot deal, the vendor and the factoring company are engaging in a single transaction. In what’s called a regular factoring arrangement, the factoring company will have an ongoing relationship with its borrower and they likely have an approved limit, which can be drawn, repaid, and redrawn again – based on newly issued invoices.

All else being equal, regular, recourse, and notification deals are less risky for a lender (or a factoring company); non-recourse, non-notification, and spot deals are more risky .

While accounts receivable factoring is most frequently used by smaller businesses, it can work with any type of company (as long as it sells on credit terms). However, it is very common in a smaller subset of specific industries, where:

• Collection times are long or unpredictable – like independent trucking and logistics companies.
• Collections and disbursements are uneven – like temporary staffing agencies, where employees are paid bi-weekly by the agency but its invoices may only be settled by the employer monthly (or longer).
• Invoice settlement is dependent upon a different party in the value chain settling its invoice – like with Construction sub-trades (plumbing, framing, HVAC, etc.); tradespeople complete work today but are only paid by the general contractor (GC) once the project owner or the real estate developer settles its invoice with the GC.

Thank you for reading CFI’s guide to Accounts Receivable Factoring. To keep advancing your career, the additional CFI resources below will be useful:

• Banking Products and Services Course
• Sales and Collection Cycle
• Allowance for Doubtful Accounts
• Accounts Payable
• Notes Receivables
• See all accounting resources
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• Receivables
• Notes Receivable
• Credit Terms
• Cash Discount on Sales
• Accounting for Bad Debts
• Bad Debts Direct Write-off Method
• Bad Debts Allowance Method
• Bad Debts as % of Sales
• Bad Debts as % of Receivables
• Recovery of Bad Debts
• Accounts Receivable Aging
• Assignment of Accounts Receivable
• Factoring of Accounts Receivable

Factoring of accounts receivable is the practice of transferring the ownership of accounts receivable to a company specialized in receivable collection, in exchange for immediate cash. In other words, the company that originally owns the receivables, sells them to another company called “factor” and receives immediate cash.

Factoring helps a business improve its cash flow by converting its receivables immediately into cash instead of waiting for the due dates of payments by customers. A drawback of factoring is that it is done at a discount, which means that the cash received on factoring of receivables is less than the value of the receivables transferred. This is because the factor expects a certain margin and it faces risks such as time value of money , and depending on the agreement, the risk of default by the debtors.

The parties to the factoring agreement assess the recoverability of the accounts receivable, decide whether or not the factoring agreement will be with recourse or without recourse, and then agree on a suitable discount factor to calculate the amount of fee to be charged by the factor i.e. the discount. After deducting such a fee from the value of the accounts receivable, the factor pays in cash to the originating company. The factor may also withhold an additional amount as a refundable security against any bad debts that may arise.

As a result of the above transaction, the factor gains ownership of the accounts receivable and has access to the detailed records of those receivables . The factor is specialized in receivable collection and it may actually be cost effective for businesses to factor their receivables because doing so will save costs such as wages paid to staff for following up with customers.

The factor collects cash from the debtors as the due dates approach. The procedure to be followed in a situation where a debt becomes irrecoverable, depends on whether or not the factoring agreement is with recourse.

Recourse vs non-recourse factoring

Under non-recourse factoring, the factor may set-off the sum retained as a security, if any, against any bad debts that may arise but the factor is not entitled to be reimbursed by the originating company if the total of bad debts exceed the amount of security. In other words, the additional loss on bad debts under non-recourse factoring is borne by the factor.

Under a factoring agreement with recourse, the company factoring its receivables agrees to pay bad debts in full to the factor. So if the security falls short of the total bad debts, the factor is entitled to be reimbursed for bad debts in full.

Non-recourse factoring is riskier than factoring with recourse for the factor, generally resulting in higher discount rates over factoring with recourse.

Factoring vs assignment of receivables

Factoring is different from a financing agreement involving assignment of receivables because the later uses receivables as a collateral security for a loan, but the actual ownership of the receivables and the right to collect them is not transferred as long as the loan and any related interest payments are paid in time.

The following example illustrates the journal entries to record transactions related to factoring with and without recourse:

On January 1, 20X5, Impatient Inc. factored its accounts receivable of $100,000 at a fee of 8%. Under the terms of the agreement, the company received $82,000 in cash and the rest of the amount was retained by the factor as a security for any bad debts that may arise. Any excess of this security sum over the total bad debts was agreed to be returned by the factor at the end of the accounting period i.e. December 31, 20X5.

On December 31, 20X5 the full amount of security sum was withheld by the factor because the actual bad debts totaled $11,000 exceeding the security sum.

Impatient Inc. had already provided allowance for doubtful debts in the factored accounts receivable and a bad debts expense was recognized in the income statement of year ended December 31, 20X4.

Required: Pass journal entries to record the above transactions for Impatient Inc. both under factoring with recourse and factoring without recourse.

January 1, 20X5: Here, the journal entry will be identical under both factoring with recourse and factoring without recourse.

December 31, 20X5: The journal entries will differ under the two types of factoring. Since the actual bad debts exceed the amount initially retained by the factor, Impatient Inc must pay the factor, an additional amount of $1,000 under factoring with recourse but there is no such remedy if the factoring is without recourse.

Under factoring with recourse:

Under factoring without recourse:

It is important to note that the type of factoring influences the amount of fee charged and the amount of security held by the factor and the scenario in this example is only for the purpose of comparing the two types. The amount of security retained may be zero under factoring with recourse because the agreement guarantees the factor that any debts that may turn out to be irrecoverable will be reimbursed.

by Irfanullah Jan, ACCA and last modified on Oct 29, 2020

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Trade finance is a tool that can be used to unlock capital from a company’s existing stock, receivables, or purchase orders. Explore our hub for more.

Invoice Finance

A common form of business finance where funds are advanced against unpaid invoices prior to customer payment

Supply Chain Finance

Also known as SCF, this is a cash flow solution which helps businesses free up working capital trapped in global supply chains.

Bills of Lading

BoL, BL or B/L, is a legal document that provides multiple functions to make shipping more secure.

A payment instrument where the issuing bank guarantees payment to the seller on behalf of the buyer, provided the seller meets the specified terms and conditions.

Stock Finance

The release of working capital from stock, through lenders purchasing stock from a seller on behalf of the buyer.

This allows a business to grow and unlock cash that is tied up in future income

Receivables Finance

A tool that businesses can use to free up working capital which is tied up in unpaid invoices.

Purchase Order Finance

This is commonly used for trading businesses that buy and sell; having suppliers and end buyers

Machinery & Equipment

Technology, construction, telecommunications, PPE, and electronics

Commodities & Materials

Raw materials, agricultural products, minerals, metals, and textiles

Chemical & Energy

Pharmaceuticals, chemicals, and energy products

Autos, Aerospace & Marine

Automotive, aviation, and marine industries

Pharma & Healthcare

Pharmaceuticals, healthcare equipment, and related sectors

Metals & Mining

Ores, minerals, metals, and concentrates

Finished Goods

Retail stock, e-commerce, textiles, clothing, and consumer goods

Construction & Projects

Construction, infrastructure, project finance, and green finance

Tech, Media & Telecom

Food & beverages.

Food, drink, dairy, confectionery, and alcohol

Professional Services

E-commerce, recruitment, legal services, and hospitality

Informing today's market

Financing tomorrow's trade

Soft Commodities Trader

Due to increased sales, a soft commodity trader required a receivables purchase facility for one of their large customers - purchased from Africa and sold to the US.

Metals Trader

Purchasing commodities from Africa, the US, and Europe and selling to Europe, a metals trader required a receivables finance facility for a book of their receivables/customers.

Energy Trading Group

An energy group, selling mainly into Europe, desired a receivables purchase facility to discount names, where they had increased sales and concentration.

Clothing company

Rather than waiting 90 days until payment was made, the company wanted to pay suppliers on the day that the title to goods transferred to them, meaning it could expand its range of suppliers and receive supplier discounts.

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A receivable represents money that is owed to a company and is expected to be paid in the future. Receivables finance, also known as accounts receivable financing, is a form of asset-based financing where a company leverages its outstanding receivables as collateral to secure short-term loans and obtain financing.

In case of default, the lender has a right to collect associated receivables from the company’s debtors. In brief, it is the process by which a company raises cash against its own book’s debts.

The company actually receives an amount equal to a reduced value of the pledged receivables, the age of the receivables impacting the amount of financing received. The company can get up to 90% of the amount of its receivables advanced.

This form of financing assists companies in unlocking funds that would otherwise remain tied up in accounts receivable, providing them with access to capital that is not immediately realised from outstanding debts.

FIG. 1: Accounts receivable financing operates by leveraging a company’s receivables to obtain financing.  Source: https://fhcadvisory.com/images/account-receivable-financing.jpg

Restrictions on the assignment of receivables – New legislation

Invoice  discounting  products under which a company assigns its receivables have been used by small and medium enterprises (SMEs) to raise capital. However, such products depend on the related receivables to be assignable at first.

Businesses have faced provisions that ban or restrict the assignment of receivables in commercial contracts by imposing a condition or other restrictions, which prevents them from being able to use their receivables to raise funds.

In 2015, the UK Government enacted the Small Business, Enterprise and Employment Act (SBEEA) by which raising finance on receivables is facilitated. Pursuant to this Act, regulations can be made to invalidate restrictions on the assignment of receivables in certain types of contract.

In other words, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses is unenforceable. Especially, in its section 1(1), the Act provides that the authorised authority can, by regulations “make provision for the purpose of securing that any non-assignment of receivables term of a relevant contract:

• has no effect;
• has no effect in relation to persons of a prescribed description;
• has effect in relation to persons of a prescribed description only for such purposes as may be prescribed.”

The underlying aim is to enable SMEs to use their receivables as financing to raise capital, through the possibility of assigning such receivables to another entity.

The aforementioned regulations, which allow invalidations of such restrictions on the assignment of receivables, are contained in the Business Contract Terms (Assignment of Receivables) Regulations 2018, which will apply to any term in a contract entered into force on or after 31 December 2018.

By virtue of its section 2(1) “Subject to regulations 3 and 4, a term in a contract has no effect to the extent that it prohibits or imposes a condition, or other restriction, on the assignment of a receivable arising under that contract or any other contract between the same parties.”

Such regulations apply to contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money. However, there are several exclusions to this rule.

In section 3, an exception exists where the supplier is a large enterprise or a special purpose vehicle (SPV). In section 4, there are listed exclusions for various contracts such as “for, or entered into in connection with, prescribed financial services”, contracts “where one or more of the parties to the contract is acting for purposes which are outside a trade, business or profession” or contracts “where none of the parties to the contract has entered into it in the course of carrying on a business in the United Kingdom”. Also, specific exclusions relate to contracts in energy, land, share purchase and business purchase.

Effects of the 2018 Regulations

As mentioned above, any contract terms that prevent, set conditions for, or place restrictions on transferring a receivable are considered invalid and cannot be legally enforced.

In light of this, the assignment of the right to be paid under a contract for the supply of goods (receivables) cannot be restricted or prohibited. However, parties are not prevented from restricting other contracts rights.

Non-assignment clauses can have varying forms. Such clauses are covered by the regulations when terms prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.

Overall, these legislations have had an important impact for businesses involved in the financing of receivables, by facilitating such processes for SMEs.

Digital platforms and fintech solutions: The assignment of receivables has been significantly impacted by the digitisation of financial services. Fintech platforms and online marketplaces have been developed to make the financing and assignment of receivables easier.

These platforms employ tech to assess debtor creditworthiness and provide efficient investor and seller matching, including data analytics and artificial intelligence. They provide businesses more autonomy, transparency, and access to a wider range of possible investors.

Securitisation is an essential part of receivables financing. Asset-backed securities (ABS), a type of financial instrument made up of receivables, are then sold to investors.

Businesses are able to turn their receivables into fast cash by transferring the credit risk and cash flow rights to investors. Investors gain from diversification and potentially greater yields through securitisation, while businesses profit from increased liquidity and risk-reduction capabilities.

References:

https://www.tradefinanceglobal.com/finance-products/accounts-receivables-finance/  – 28/10/2018

https://www.legislation.gov.uk/ukpga/2015/26/section/1/enacted  – 28/10/2018

https://www.legislation.gov.uk/ukdsi/2018/9780111171080  – 28/10/2018

https://www.bis.org/publ/bppdf/bispap117.pdf  – Accessed 14/06/2023

https://www.investopedia.com/terms/a/asset-backedsecurity.asp  – Accessed 14/06/2023

https://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf  – Accessed 14/06/2023

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Using Receivables to Generate Cash

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on March 23, 2023

Fact Checked

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Table of Contents

Often in real life, a company's management will decide that it would rather have cash immediately than wait for receivables to be collected.

There are two broad approaches to generating cash from receivables. In one, the receivables are pledged as collateral for a loan.

In the other, the receivables are assigned to another party (a factor ), much in the same sense that other assets are sold.

However, there are characteristics of these assignments that prevent some of them from being exactly like a sale. The illustration below summarizes the four possible methods:

• Assignment with recourse (assignor collects)
• Assignment with recourse (factor collects)
• Assignment without recourse

The use of non-uniform terms in practice makes it even more difficult to understand these practices. The meaning of pledging is generally unambiguous and, therefore, there is no problem.

However, many persons refer to the act of assigning as factoring. Some have even used assignment to refer to situations in which accounts are assigned with recourse while using factoring to refer to situations where there is no recourse.

We have chosen the approach in this category for its descriptiveness, simplicity, and similarity to legal usage.

We encourage the reader to understand the concept of each approach. Then, when these situations are encountered in practice, they will be accounted for according to their nature rather than the terminology used.

This example demonstrates disclosures when receivables are used to generate cash. Consider the following information about the Rath Packing Company's current assets:

NOTE 5: Financing Agreement

All receivables and inventories have been pledged as collateral for borrowings under a financing agreement.

The lender is a commercial finance company; however, two banks participated in the borrowings up to a maximum amount of $4,000,000 until 3 September 2018.

One of the banks has continued to participate up to a maximum amount of $2,000,000 since that date.

The total amount available for borrowing under the agreement varies as determined by the commercial finance company. It amounted to $10,000,000 on 27 September 2018.

Using Receivables to Generate Cash FAQs

What are accounts receivable.

Accounts Receivable (A/R) refers to the outstanding invoices a company has issued to its customers for products or services sold, but which have not yet been paid. This represents the money that a company is owed by its customers for goods or services that have been delivered but not yet paid for.

What are the methods used to generate cash from receivables?

There are four basic methods: (1) pledge accounts receivable as collateral for a loan; (2) assign accounts receivable with recourse, also known as factoring; (3) assign accounts receivable without recourse, and (4) use accounts receivable as collateral for a standby letter of credit.

What are the benefits of using receivables to generate cash?

There are several benefits to using receivables to generate cash. First, it can help improve a company's cash flow situation by increasing the amount of money coming in. Second, it can help a company better manage its working capital, as it can use the cash generated from receivables to pay down other debts or invest in new inventory. Finally, using receivables to generate cash can help a company build stronger relationships with its customers, as they will see that the company is willing to work with them to get paid.

What are the risks associated with using receivables to generate cash?

There are a number of risks associated with using receivables to generate cash. The most obvious risk is that a company may not be able to collect all of the money it is owed. This could significantly reduce or even eliminate the benefits of using receivables to generate cash. Additionally, a company that relies too much on receivables to generate cash may end up taking on too much risk, which could lead to financial problems down the road.

How can I maximize the benefits and minimize the risks of using receivables to generate cash?

There are a few things a company can do to maximize the benefits and minimize the risks of using receivables to generate cash. First, it is important to have a solid understanding of one's customers and their payment habits. This will help a company better assess which receivables are most likely to be paid on time and which ones are more likely to go unpaid. Second, a company should have strong internal controls in place to ensure that all receivables are properly managed and collected. Finally, a company should consider using a third-party service to help manage its receivables and collection efforts. This can take some of the burdens off of the company and help improve its chances of successful collections.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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