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What is Pledging Receivables? – With Examples

21 September, 2022
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What you'll learn

  • Businesses use their accounts receivable as collateral for a loan to get capital needs
  • Learn how lenders determine the loan amount against the pledged amount.
CONTENT
What are pledging receivables? 
Example of pledging receivables
How do you pledge receivables?
To sum it up 
FAQs
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Businesses often need to resort to short-term loans to finance their working capital. This is especially true during difficult market conditions when receivables do not get converted to cash as planned.

But banks and financial institutions are often reluctant to offer loans to small and mid-sized businesses (SMBs) as they consider them riskier to service. In such scenarios, many SMBs resort to accounts receivable and inventory financing to raise working capital for daily operations. 

They surrender or pledge their receivables in return for financing options such as loans. Utilizing accounts receivable(AR), or customers’ credit accounts, to obtain finances for your business is a method of meeting working capital needs. By pledging the receivables, businesses gain capital for themselves.

Businesses are frequently offered accounts receivable funding by commercial finance organizations in lieu of their account receivables as collateral—it’s a flexible financing option. But what exactly is accounts receivable pledging in terms of business financing?

What are pledging receivables? 

Pledge receivables are the accounts receivables that you submit as collateral to the lender against a pre-decided loan(or capital funds). When you pledge or assign the AR, you are effectively using them as security to receive cash. Although the receivables are held as collateral by the lender, you, as the business owner, are still responsible for collecting debts from your credit clients.

When accounts receivable is handled in this way, the lender usually limits the loan amount to one of the following:

  1. 70% to 80% of the entire amount of outstanding accounts receivables; or
  2. A fraction of accounts receivables based on the age of the receivables.

The second option above is safer from the lender’s perspective and is more common as it allows for accurate identification of receivables that are less likely to be collected. Typically, the lender will only accept receivables that are not past-due date. Accounts that are past due do not make suitable collaterals.

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Also, if a customer is given credit terms that the lender believes are excessively long, the lender may refuse to accept those receivables as collateral. After evaluating a company’s receivables for overdue accounts, the lender decides how much of the receivables they will accept.

the garment industry accounts for about 80% of all U.S. factoring

Example of pledging receivables

Let’s say Company A borrows $80,000 on December 31, 2021, and agrees to repay $81,600 on April 1, 2022. It pledges $100,000 in trade receivables as collateral for the loan. The company would make the following three journal entries:

31/12/2021 Cash $80,000
Notes Payable $80,000
31/03/2022 Interest Expense $1,600
Notes Payable $1,600
01/04/2022 Notes Payable $81,600
Cash $81,600

The last two entries can be combined, however, they are shown separately here to make pledging and the other approaches more comparable.

Notes or parenthetical comments are the only financial statement disclosures for pledged receivables. For the payable notes, a similar indication is provided.

How do you pledge receivables?

Post examining the receivables of a company and analyzing them for overdue accounts and the terms, the lender determines the amount of receivables they consider eligible to a loan. The amount for allowances and returns are then adjusted as per the decision and the percentage of acceptable receivables is determined to loan the money. If a business defaults on the AR financing loan, the lender will take over the company’s AR and collect the debts themselves.

When it comes to recording the pledged receivables, journal entries are not  necessary. The lender, however, still has to approve your AR before making the loan.

To sum it up 

Businesses use a variety of methods to fund their operations and stay financially viable. Traditional fundraising methods entail issuing debt or equity securities in public markets or through private channels. Pledging accounts receivable, financing through fixed-asset attachment procedures, and factoring receivables from customers are all examples of types of corporate finance.

Using accounts receivable as collateral for a loan is essentially the same as using any other asset as collateral. A loan is received by pledging an asset to repay a lender. The collateral will be changed to cash if the loan is not repaid, and the cash will be used to pay off the obligation.

FAQs

  1. What is the difference between pledging receivables and assigning receivables?
  2. When a business pledges its accounts receivable, it does so as a form of loan collateral. When a business assigns its accounts receivable to a financial institution, it enters into a lending agreement with the bank to receive payment on specific customer accounts.

  3. Is pledging and factoring receivables exactly the same process?
  4. In pledging receivables the business promises its account receivables as collateral and gets into a pledging agreement with the lender. The company retains title to and is responsible for collecting accounts receivable, not the lender whereas, in factoring receivables, businesses opt to sell or assign its account receivable (or a specific invoice) to a factoring company in exchange for cash at a discount to its face value. The factor is then responsible for collecting the receivables.

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