The accounts receivable of a small business is often that business's largest and most valuable asset. But it's a non-performing asset. In other words, it never grows in value and, with inflation and the fact that many debtors do not pay in a timely manner, its value could actually decrease over time. One way to address this problem is to engage in accounts receivables financing.
Through this type of transaction, a business can turn its A/R balance from a non-performing asset to one that adds value for the business owner. It can also provide protection for the A/R balance from the claims of creditors. This latter is of special benefit to medical practitioners as it protects the accounts receivable asset in the event of a malpractice suit. Other small business owners who must maintain some sort of liability insurance-especially those who offer services instead of products-may find this type of transaction beneficial in the same way.
Receivables financing is essentially a loan against a firm's accounts receivable balance. But it differs from a bank loan or other corporate credit option in a few ways. Instead of some tangible asset such as equipment or real estate, the business's A/R balance will be the collateral for the loan. Instead of any arbitrary dollar figure, the loan amount will be based on the A/R balance-either the full balance or what is called the "collectible" balance. This latter takes into consideration any potentially uncollectible portion of the A/R balance. For the duration of the loan, the bank that is extending the loan will place a lien against the A/R balance, thus protecting it from the potential of future claims from other creditors of the business.
What does a business do with the loaned proceeds that it receives from receivables financing? In many cases the funds are used to pay the premiums on a cash value life insurance policy for the business owner. It should be noted that in such a case, the bank may require the insurance policy to act as secondary collateral for the loan. The borrowed funds may also be used to supplement the business owner's retirement income through specific types of investments. The business owner-or in some cases, the business itself-is responsible for repaying the loan to the bank in regular monthly installments. Failure to pay would result in seizure of the accounts receivable balance by the bank, along with the value of the insurance policy if it is indeed used as secondary collateral.
Other uses for the proceeds of receivables financing could be expanding the business or buying new equipment. For that type of use, a bank is seldom the source of the loan. Instead a factoring service buys all or a portion of the business's accounts receivable, charging the business a fee for doing so. The debtors (individuals or businesses that owe the business that is selling its accounts receivable) are then responsible for paying their debt to the factoring service.
There may be tax issues involved in either of these types of financing, so a business should consult a tax accountant and/or lawyer to ensure that everything is set up correctly. At the very least, a bank or factoring service that specializes in these financial transactions should be used. But however such financing is set up, the benefits usually outweigh any risks that might be involved. The results will be a better use of a company's accounts receivable balance than just letting it sit there.
Corporate Credit Concepts specializes in Receivables Financing. For more information about Receivables Financing and how it might benefit your business, please CLICK HERE for a free phone consultation.