The first thing you need to know about factoring accounts receivables is that these appear as assets on a balance sheet. Yes, an asset. If someone owes you money for services provided in the past or future, that is an asset. And you can bank on that asset. You can get loans based on someone owing you money! So a company could extend 90 day same as cash and increase its value on its books. It is also interesting to note that accounts payable is considered a liability.
If this sounds too good to be true, it is. Consider which company you would want to work for: One that has a billion dollars in cash and investments, or one that is owed a billion dollars? And if you don't want to work for them, do you really want to invest in them? What you are doing when you are factoring accounts receivables is analyzing the corporate credit the company has extended to others.
Factoring accounts receivables requires a different view; first, consider the assets without the accounts receivables, or better divide the accounts receivables by the amount of quick assets. How does it compare to other companies in the sector? Second, what is the normal expectation in this business, ten days same as cash, or twenty? Third, what is the default rate? If the company you are looking at is better than average in these areas then it would be appropriate to consider the receivables as a positive when factoring accounts receivables. Be careful when you invest to look at this issue. What is normal in one business is not in another. Remember we are talking about accounts receivables, money owed for services rendered or product delivered. So we are not talking about banks - the same principles apply, but the terminology and accounting is different.
Let's look at a banking example: in the middle ages the Knights of the Temple of Solomon were losing big in Jerusalem. Driven out they returned to France, since the King of France owed then a fortune they considered themselves safe. They were the bankers of the middle ages, and the powerful king was considered a good risk. You don't want to piss off your banker, unless you've just made a deal with another major loan holder. The king launched a raid and seized the Knights and their wealth. They appealed to the Pope, who also owned them money, too much money. He was in league with the King of France. The Knights were tortured to confess, and then burned at the stake. The raid was launched on Friday the 13th. This is why it is considered unlucky, especially if you are a Knight Templar! The raid amounted to a coup on the major bank of the era. It dramatically curtailed credit and growth in the thirteenth century. The Knights needed a more diverse cliental and tighter credit limits.
This is a huge issue in factoring accounts receivables, who owes the company and what percentage of the receivables is owed by the biggest debtor? This ratio is a great way to assess the risk of your accounts receivable. I know a man who lost it all when the person who owed him money defaulted. This wasn't a default on a loan. This was a receivable that turned into a loan when it got so far behind. Each month the company got made partial payment, and took the same deliveries of goods. They were a startup and needed a little help. My friend was helpful, too helpful. The debtor dragged his creditor into bankruptcy with him.
The last example is Dell Computers. They negotiated 90 days same as cash for parts, and get paid before the computer is built! That means they get up to 100 days of interest on the cash you pay for your computer. Financing is how Dell made its fortune, well financing and good machines. But lots of companies made good machined, Dell's business practices were what separated it from the others. Dell has little or no accounts receivables and big accounts payable. Lower assets and higher liabilities - not the normal equation for success.
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