On first blush, selling accounts receivables may look like just another flavor of lending. However, it is actually subtly different.
With accounts receivable financing, a company is paying for faster access to their own cash. With AR purchasing, there is a transfer of ownership.
Under the agreement, a finance company purchases accounts receivable or factors invoices and the legal ownership of the invoice is transferred to the financing company. This can have a variety of implications on how the transaction is serviced, how the risk is shared, and how to account for it.
Usually when a business financing company buys receivables then the payments on invoices related to the financing are paid directly to the financier into its lockbox. This is also known as full-notification factoring. Under such an agreement there is risk sharing since accounts receivables are often purchased under what are known as non-recourse agreements. In these types of arrangements, not only does the financier provides cash upfront against invoices yet to be paid, but it also assumes the risk of non-payment on the invoices in the event of an insolvency of the obligor on the invoice.
This provides an added level of credit risk protection to the company selling its invoices. A loan against receivables does not provide this type of protection to the borrower.
This type of arrangement does have accounting implications. When a company borrows against its receivables, it shows reports invoices on the asset side of the balance sheet and a corresponding liability for the loan on the liability side. In AR Financing, the company seeking financing no longer shows the invoices on its balance sheet and there is no liability record. The transaction is, typically, recorded as a sale of company assets to the financier or factor. Which is just one of the benefits of Accounts Receivable Financing.
When receivables are factored then the company seeking financing no longer shows the invoices on its balance sheet and there is no liability record. The transaction is, typically, recorded as a sale of company assets to the financier or factor.