Borrowing on Receivables

Rather than delving into the complicated realm of credit-policy changes, many companies use a receivables securitization program. In this case, I'm talking about accounts receivable, which include all accounts of customers who buy on credit. In this type of program, a company sells its receivables to an outside party — usually a bank or other financial institution — to get immediate cash, and as the receivables come in from customers, the company repays the financial institution. Most companies retain the servicing rights of the receivables, which means that they continue to collect from customers and receive servicing fees for administering that collection.

Two standard options for selling receivables are

✓ Selling the receivable for less than it's worth: For example, a program's terms may dictate that the company gets 92 cents for each dollar of receivables, which, in essence, is equivalent to an 8 percent interest rate.

✓ Paying interest as if the company had taken out a loan secured by a physical asset, such as a building: For example, the company's credit terms for the securitization program may set up an annual interest rate of 8 percent. But for customers who pay their bills within 30 days, the amount of interest the company actually pays on the accounts receivable loan is only 1/12 of 8 percent for the one month they borrowed the money while waiting for a customer to pay.

In addition, companies usually have to pay upfront charges of 2 to 5 percent to set up the program.

The biggest advantage of using a receivables securitization program is that the company has immediate access to cash. The biggest disadvantage is that the company ends up with less than the full value of the receivables when it collects from its customers because of discounts or any interest paid on those receivables.

You can find out whether a company uses a securitization program by reading the notes to the financial statements. If a company does use this type of financing, it will include in the notes information about money it has borrowed on a short-term basis, which is called short-term financing.

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