Trade Accounts Receivable (AR) represents the credit a company extends to its business
partners. AR is essentially an approach to financing customers’ business operations, using the supplier company as the lender rather than a bank or other source. Particularly when markets are slow-moving and cash availability is low, trade credit tends to be what keeps businesses in business. AR is a business asset (which explains why it shows up on the balance sheet), because it is something the business has that is of value. When the business needs to get a little of its own financing, should an approach using AR as the basis be a consideration? Is it even possible?
Does Your Customer Data Support the Value of Your Receivables?
AR “financing” means that the business trade accounts receivable are the main consideration of the lender in providing financing, where the AR is either collateral for the loan or is a factor making the business eligible for the loan. There are many types of AR-based financing, and there are still more issues to think about before trying to use AR as a financing tool.
When it comes to other assets in the business, the information about them is probably pretty well-known. Physical assets in particular don’t leave a lot of question as to their value – at least in terms of what was paid for them and then depreciated over time. Other assets, like Accounts Receivable, are a bit more difficult to value. Realistically, the value of the AR may not actually BE the book value of the AR, because not all of that money may be able to be collected. Considering that companies fail or go bankrupt or experience other events which cause them to default on obligations, there is risk connected to the AR and, subsequently, a question of whether or not it makes sense to “leverage” that AR for immediate cash.
There is research out of the Columbia School of Business (among other sources) which discusses a condition called “information asymmetry” and how it may impact the business decision to use AR financing. The research discusses the fact that Accounts Receivable, unlike other business assets, contains information about other companies and the value is ultimately dependent upon that information and how well recognized it is by others. There are two factors to look at: how much more information you have on your customers than on other assets (the asymmetry) and how much risk is associated with that information. Whew. Let’s break it down this way:
Consider that you have extended business credit to a number of customers, and you have a ton of information on those customers indicating that they are good credit risks (which is why you extended them credit in the first place). Consider also that some of your customers are public company or government, and some are private company. The information related to the public and government entities is less risky than the information you have on the private company, because it’s easier to substantiate through publicly available information than is the private company information. Your prospective lender may need to use this information to support collateralizing the value of the AR, and it may or may not work in your favor in terms of supporting the value of the asset.
The whole point of this is that it is critical to gather and maintain information on customers and their financial stability so that the company could potentially use its trade receivables to acquire financing to support operations or retire other debt when required.
About the Author:
Joanie Mann is a recognized authority in the areas of ISV cloud enablement and ASP service delivery. Her extensive work with accounting professionals worldwide has positioned her as an expert consultant and adviser to practitioners looking to leverage cloud accounting solutions, web-based applications and Internet technologies in their firms and with their clients.
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