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Accounts receivable is money owed to a business by its clients for services or merchandise usually purchased on credit. In some cases, the debts have been owed for quite a while and may not appear to be collectible.
These debts, as well as more recent debts, can be sold to finance or factoring companies that assumes the debt and take on the challenges of collecting them. The business that sells the debt receives immediate cash that can be put back into the business to purchase inventory or improve other areas of the company. The time employees spend trying to collect these debts can also be used in a more profitable way other than chasing debt payments.
However, these accounts receivable are sold at a discount, meaning, the the business selling their accounts receivable will not get their full value. The older the debt, the greater the discount that will probably be required to sell them.
The cost of doing business with companies purchasing accounts receivable, considering the discounts and other charges, can be higher than a bank loan. For this reason, other forms of financing should be investigated before considering this plan.
This method of financing is more often used by small businesses because of their smaller capital reserves. This can lead to an immediate need for cash without the time to work through bank loan paperwork. A business considering accounts receivable financing should look around for the best deal and be sure this strategy of raising cash matches their business plan.
Because companies that purchase accounts receivables are not as regulated as some financial institutions, all contract should be read carefully, all companies investigated, and discounts can be negotiated. This strategy can save a small business facing bankruptcy, but it can be an expensive solution.
