Accounts Receivable Financing
What it is:
How it works/Example:
Let's say Company XYZ sells widgets. It has about $1 million in
Company XYZ needs right away because it is trying to finish building a factory. is an asset, and as such, it appears on the balance sheet. In particular, is a current asset, meaning that the amount owed is expected to be received within the next 12 months.
Company XYZ calls a , which purchases the receivables for $750,000. In the deal, Company XYZ gets $750,000 right away, and the factor gets the right to all the from the receivables ($1 million). A factor is a financial institution that purchases receivables from a company. The factor then assumes the risk of customers paying late or not paying at all.
Why it matters:
Accounts receivable financing can be a complicated process, but the basic idea is that companies can trade cash flows now, which is very useful for companies that need cash right away. It can also be expensive, as the example shows (Company XYZ gave up $250,000 of its for the deal).
Because assume the risk of collecting the receivables, they are very choosy about which companies they work with and the creditworthiness of the companies' customers.