You sold a product. The customer took it. However, the money has not yet been deposited into your bank account.
The difference between delivery and payment is in Receivables. These are simply amounts owed to your business by customers who purchase goods or services on credit. I haven’t received a promissory note. I have not received a signed release form. All you have to do is open the books and logged the debt as a current asset.
It’s not just accounting. For most companies, this is a significant amount of money. These assets tend to expand and contract in direct response to sales. If you sell more, you’re owed more.
The hidden costs of instant cash
If you need liquidity, but you don’t have cash lying around, you can’t always wait. Waiting for invoices to clear can slow down your business.
Many companies rely on accounts receivable financing. It’s an instant way to turn unpaid invoices into cash. But here’s the problem. It’s expensive.
Unlike factoring, where you inform the customer that the account has been sold to a third party, this method allows you to hide it from the customer. They will still pay you. If they don’t pay, you’re still responsible for the credit losses. Finance companies and banks only see your book.
Accounts receivable financing is considered a relatively expensive form of borrowing.
Who really uses this?
This is not for Fortune 500 companies.
Large companies have other options. They have very liquid assets. They have deep credit lines. They don’t need to pawn their customer lists.
Accounts receivable financing is typically used by small and medium-sized companies. These companies cannot get additional financing from commercial banks. There is a lack of collateral usually required by banks. They have no other liquid assets to use as collateral.
That’s why they pledge their receivables. Or they may sell it to a finance company without notifying the customer. This is a flexible source of credit as the amount available varies depending on sales volumes. Sell more? You can borrow more.
Compromise
There are no free lunches in the financial industry.
You get cash flow right away. You can avoid the strict supervision of traditional bank loans. You don’t alert your customers to financial distress.
However, this flexibility has to be paid for. secured receivables financing have higher interest rates and fees than regular bank loans. Basically, you pay a premium for speed and privacy.
Is it worth it?
Only if the alternative is to shutting down operations. Only if you can’t get a bank loan. This is a stopgap. It’s a bridge.
It’s not a strategy.
When dealing with this debt, remember the other side of the bookkeeping. Accounts payable. You owe it to others. It’s a completely different beast. But that’s a question for another day.
