Selling Accounts Receivable: The Ultimate Guide

28 May, 2024
10 mins
Timothy Fogarty, AVP, Digital Transformation

Table of Content

Key Takeaways
Introduction
What is Accounts Receivable?
What Does Selling Accounts Receivable Mean?
What are the Steps Involved in Selling Accounts Receivable?
5 Reasons Why a Company Would Sell Its Receivables
Disadvantages of Selling Accounts Receivable
Should You Sell Your Accounts Receivable?
Wrapping Up
FAQs

Key Takeaways

  • Selling accounts receivable can provide immediate cash flow relief for businesses facing monetary challenges due to delayed payments from customers.
  • Generally, small businesses that need instant cash resort to selling their receivables to third-party organizations. 
  • Companies sell receivables to improve cash flow, mitigate credit risk, focus on core operations, and seize growth opportunities.
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Introduction

We all know that cash flow can make or break a business, but did you know that effectively managing accounts receivable (AR) plays a crucial role in maintaining a healthy cash flow? What if your customers don’t pay on time, causing your AR to take longer to turn into cash? 

This delay can significantly impact your cash flow. So, how can you tackle this issue?

One solution is accounts receivable factoring, which involves selling your accounts receivables to get cash quickly. Unsure about what accounts receivable factoring entails and how it works? Well, this guide will walk you through what it means to sell accounts receivable, how it can help your business, and whether selling accounts receivable is right for your business.

What is Accounts Receivable?

Accounts receivable is the money owed to a business by its customers for goods or services that have been delivered but not yet paid for. It represents the outstanding invoices or amounts receivable from clients or customers and is considered an asset on the business’s balance sheet.

What Does Selling Accounts Receivable Mean?

Selling accounts receivable means turning the money you’re owed into cash right away. Instead of waiting for customers to pay their bills, you sell those unpaid invoices to a third party, usually at a discount, in exchange for immediate cash. It helps you manage your business operations smoothly.

Accounts Receivables Factoring

Let’s assume you run a B2B retail business selling office supplies to various companies. When you deliver goods to a client, they receive an invoice with payment terms of 30 days. However, instead of waiting for the full 30 days to receive payment, you can sell that invoice to a financial institution or factor. They’ll pay you a portion of the invoice value upfront, allowing you to have immediate cash on hand to cover your business expenses. This process of selling your accounts receivable is akin to getting paid instantly rather than waiting for your client to settle their bill.

What are the Steps Involved in Selling Accounts Receivable?

Selling accounts receivable involves evaluating and selecting unpaid invoices, making agreements with factoring companies, verifying the validity of the receivables, and selling them at a discounted rate. Once sold, the buyer takes over the responsibility of collecting payments from debtors.

Process Of Selling Accounts Receivable

1. Evaluation:

Assess the accounts receivable portfolio to determine which invoices or receivables to sell. Consider factors such as the age of the receivables, customer creditworthiness, and the total outstanding amount.

2. Choose a financing option:

Select the appropriate financing method based on your business needs and preferences. Options include invoice factoring, invoice discounting, asset-based lending (ABL), supply chain finance (SCF), or peer-to-peer (P2P) lending.

3. Find a buyer or lender:

Research and identify potential buyers or lenders who offer accounts receivable financing. This may include traditional financial institutions, specialized lenders, or online platforms.

4. Negotiate terms:

Initiate discussions with potential buyers or lenders to negotiate terms and conditions of the financing arrangement. Key considerations include advance rates, discount rates, fees, repayment terms, and recourse options.

5. Due diligence:

Provide relevant documentation and information about the accounts receivable portfolio to the buyer or lender for due diligence purposes. This may include invoices, customer information, aging reports, and financial statements.

6. Make an agreement:

Once terms are agreed upon and due diligence is completed, formalize the financing arrangement by signing a contract or agreement outlining the terms, rights, and obligations of both parties.

7. Funding:

Upon agreement execution, the buyer or lender will advance funds to the seller, typically a percentage of the total accounts receivable value. The seller receives immediate cash flow, which can be used to meet working capital needs or invest in business growth initiatives.

8. Repayment:

As customers pay their invoices, the buyer or lender collects the receivable amounts directly. Repayments are applied to the outstanding balance, and any remaining funds, minus fees or discount charges, are remitted to the seller.

9. Monitoring and management:

Continuously monitor the accounts receivable financing arrangement, track customer payments, and manage communications with the buyer or lender. Stay proactive in addressing any issues or discrepancies to ensure smooth operations.

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5 Reasons Why a Company Would Sell Its Receivables

Selling receivables gives companies flexibility, risk reduction, and improved financial stability, enabling them to navigate cash flow challenges and seize growth opportunities more effectively.

  1. Immediate Cash Flow: Selling receivables allows companies to convert their outstanding invoices into cash quickly, providing immediate funds to cover expenses, invest in growth opportunities, or manage day-to-day operations.
  2. Risk Mitigation: By selling receivables, companies transfer the risk of late payments or non-payment to the buyer. This reduces the company’s exposure to credit risk and ensures a more predictable cash flow.
  3. Working Capital Management: Selling receivables improves liquidity and working capital management. It enables companies to access funds without taking on additional debt or diluting ownership through equity financing.
  4. Focus on Core Operations: Outsourcing receivables management to a buyer allows companies to focus on their core business activities. They can delegate the tasks of invoice processing, collections, and credit risk assessment to the buyer, freeing up time and resources.
  5. Opportunity Cost: Holding onto receivables ties up capital that could be deployed elsewhere. By selling receivables, companies can avoid the opportunity cost of waiting for payments and instead reinvest the cash into areas that generate higher returns.

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Disadvantages of Selling Accounts Receivable

Selling accounts receivable has its advantages and disadvantages. While it helps businesses with cash flow, it comes at a cost in the form of interest. Let’s uncover the advantages & disadvantages of selling receivables. 

Disadvantages:

  1. Loss of potential future profits from receivables: When selling receivables at a discount, businesses forfeit the potential future profits they would have earned from collecting the full value of the invoices.
  2. Cost of factoring or discounting fees: Factoring or discounting companies charge fees for their services, reducing the overall amount received from selling receivables and impacting profitability.
  3. Potential impact on customer relationships: Outsourcing the management to companies that buy account receivables may affect customer relationships if the buyer adopts aggressive debt collection practices or communicates poorly with clients.
  4. Dependence on external financing for cash flow: Relying heavily on selling receivables for cash flow can create a dependency on external financing sources, potentially limiting the business’s ability to secure traditional loans or lines of credit in the future.
  5. Potential loss of control over the receivables process: When selling receivables, businesses relinquish some control over the accounts receivable process to the buyer, which may lead to a loss of autonomy in managing customer payments and credit policies.

Should You Sell Your Accounts Receivable?

Whether to sell your accounts receivable depends on your business’s specific financial situation and needs. Selling accounts receivable can provide immediate cash flow, mitigate credit risk, and free up resources for other business activities. However, it typically involves selling invoices at a discount, which means you’ll receive less than the full invoice value. 

Additionally, selling receivables may impact customer relationships if handled improperly. Therefore, carefully weigh the pros and cons and consider consulting with financial advisors before making a decision.

Wrapping Up

Cash flow issues pose a significant threat to the growth and profitability of any business. To mitigate this risk, it’s imperative to ensure timely customer payments and effectively managing accounts receivables is critical to achieve this goal. However, when handled manually, collections can be challenging, especially at scale. That’s where automation can significantly support your collection team.

At HighRadius, we help you streamline your collection process. With our AI-powered AR automation software, you can auto-prioritize accounts and set up automatic reminders for low-risk customers. This allows you to concentrate on at-risk accounts.

Also, we let you offer your customers the flexibility to pay in their preferred format- through wire transfer, ACH, direct debit, credit or debit card — online, through instant or scheduled payments, ensuring they can settle up at their convenience, which in turn increases the chances of them paying you. 

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FAQs

1) Can accounts receivable be sold?

Yes, selling accounts receivable for cash is possible through a process called factoring or accounts receivable financing. In this arrangement, a business sells its outstanding invoices to a third-party financial institution at a discount in exchange for immediate cash, thereby improving cash flow and mitigating credit risk.

2) Why would a company sell receivables to another company?

A company might sell receivables to improve cash flow, mitigate credit risk, and expedite access to funds. By selling outstanding invoices to a third-party financier at a discount, businesses can secure immediate cash rather than waiting for customers to pay, enhancing liquidity and financial stability.

3) Who do you sell accounts receivable to?

Accounts receivable can be sold to factors, financial institutions, or specialized firms known as Accounts Receivable Management (ARM) companies. These entities purchase outstanding invoices at a discounted rate, providing immediate cash flow to businesses in exchange for assuming the responsibility of collecting payments from customers.

4) How to sell accounts receivable?

To sell accounts receivable, you need to evaluate them, select which ones to sell, enter into agreements with buyers, verify the receivables’ validity, and sell them at a discounted rate.

5) Can we sell accounts receivable for short-term funds?

Yes, selling accounts receivable can provide short-term funds by converting unpaid invoices into immediate cash, improving cash flow to meet immediate financial needs.

6) Do we need to sell accounts receivable at a discount?

Yes, accounts receivable are typically sold at a discount, as buyers assume the risk of collecting payments from debtors and charge fees for their services. This discount reflects the time value of money and the risk associated with collecting the receivables.

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