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Assignment of Accounts Receivable: Meaning, Considerations
Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.
Investopedia / Jiaqi Zhou
What Is Assignment of Accounts Receivable?
Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.
The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.
- Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
- This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
- Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
- Accounts receivable are considered to be liquid assets.
- If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.
Understanding Assignment of Accounts Receivable
With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .
An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.
New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.
Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.
Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.
Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.
The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.
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Assignment of accounts receivable
What is the assignment of accounts receivable.
Under an assignment of accounts receivable arrangement, a lender pays a borrower in exchange for the borrower assigning certain of its receivable accounts to the lender. If the borrower does not repay the loan , the lender has the right to collect the assigned receivables. The receivables are not actually sold to the lender, which means that the borrower retains the risk of not collecting payments from customers .
The amount loaned is usually a percentage of the outstanding receivables in the accounts assigned to the lender. The exact terms may vary - for example, the lender may require that all receivables be assigned to it. Under this arrangement, the borrower pays interest on the loaned funds, as well as a service charge. In essence, the assigned receivables act as collateral for the loan. The borrower may choose to separately classify assigned receivables in a different asset account, to clarify the extent of the arrangement with the lender.
When to Use Assignment of Accounts Receivable
This type of financing is expensive, and so is only considered by entities that have failed to obtain less expensive forms of financing. It is typically used when a company is not sufficiently capitalized or is growing rapidly, and so does not have enough cash on hand to fund its operations. Other organizations are more likely to use traditional forms of financing, such as a line of credit to handle shortages in the level of working capital .
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Assignment of Accounts Receivable
The financial accounting term assignment of accounts receivable refers to the process whereby a company borrows cash from a lender, and uses the receivable as collateral on the loan. When accounts receivable is assigned, the terms of the agreement should be noted in the company's financial statements.
In the normal course of business, customers are constantly making purchases on credit and remitting payments. Transferring receivables to another party allows companies to reduce the sales to cash revenue cycle time. Also known as pledging, assignment of accounts receivable is one of two ways companies dispose of receivables, the other being factoring.
The assignment process involves an agreement with a lending institution, and the creation of a promissory note that pledges a portion of the company's accounts receivable as collateral on the loan. If the company does not fulfill its obligation under the agreement, the lender has a right to collect the receivables. There are two ways this can be accomplished:
General Assignment : a portion of, or all, receivables owned by the company are pledged as collateral. The only transaction recorded by the company is a credit to cash and a debit to notes payable. If material, the terms of the agreement should also appear in the notes to the company's financial statements.
Specific Assignment : the lender and borrower enter into an agreement that identifies specific accounts to be used as collateral. The two parties will also outline who will attempt to collect the receivable, and whether or not the debtor will be notified.
In the case of specific assignment, if the company and lender agree the lending institution will collect the receivables, the debtor will be instructed to remit payment directly to the lender.
The journal entries for general assignments are fairly straightforward. In the example below, Company A records the receipt of a $100,000 loan collateralized using accounts receivable, and the creation of notes payable for $100,000.
In specific assignments, the entries are more complex since the receivable includes accounts that are explicitly identified. In this case, Company A has pledged $200,000 of accounts in exchange for a loan of $100,000.
balance sheet , current assets , factoring , disposition of accounts receivable , allowance for doubtful accounts , special allowance accounts
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Receivables Finance And The Assignment Of Receivables
Tfg legal trade finance hub, receivables finance and the assignment of receivables.
A receivable represents money that is owed to a company and is expected to be paid in the future. Receivables finance, also known as accounts receivable financing, is a form of asset-based financing where a company leverages its outstanding receivables as collateral to secure short-term loans and obtain financing.
In case of default, the lender has a right to collect associated receivables from the company’s debtors. In brief, it is the process by which a company raises cash against its own book’s debts.
The company actually receives an amount equal to a reduced value of the pledged receivables, the age of the receivables impacting the amount of financing received. The company can get up to 90% of the amount of its receivables advanced.
This form of financing assists companies in unlocking funds that would otherwise remain tied up in accounts receivable, providing them with access to capital that is not immediately realised from outstanding debts.
FIG. 1: Accounts receivable financing operates by leveraging a company’s receivables to obtain financing. Source: https://fhcadvisory.com/images/account-receivable-financing.jpg
Restrictions on the assignment of receivables – New legislation
Invoice discounting products under which a company assigns its receivables have been used by small and medium enterprises (SMEs) to raise capital. However, such products depend on the related receivables to be assignable at first.
Businesses have faced provisions that ban or restrict the assignment of receivables in commercial contracts by imposing a condition or other restrictions, which prevents them from being able to use their receivables to raise funds.
In 2015, the UK Government enacted the Small Business, Enterprise and Employment Act (SBEEA) by which raising finance on receivables is facilitated. Pursuant to this Act, regulations can be made to invalidate restrictions on the assignment of receivables in certain types of contract.
In other words, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses is unenforceable. Especially, in its section 1(1), the Act provides that the authorised authority can, by regulations “make provision for the purpose of securing that any non-assignment of receivables term of a relevant contract:
- has no effect;
- has no effect in relation to persons of a prescribed description;
- has effect in relation to persons of a prescribed description only for such purposes as may be prescribed.”
The underlying aim is to enable SMEs to use their receivables as financing to raise capital, through the possibility of assigning such receivables to another entity.
The aforementioned regulations, which allow invalidations of such restrictions on the assignment of receivables, are contained in the Business Contract Terms (Assignment of Receivables) Regulations 2018, which will apply to any term in a contract entered into force on or after 31 December 2018.
By virtue of its section 2(1) “Subject to regulations 3 and 4, a term in a contract has no effect to the extent that it prohibits or imposes a condition, or other restriction, on the assignment of a receivable arising under that contract or any other contract between the same parties.”
Such regulations apply to contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money. However, there are several exclusions to this rule.
In section 3, an exception exists where the supplier is a large enterprise or a special purpose vehicle (SPV). In section 4, there are listed exclusions for various contracts such as “for, or entered into in connection with, prescribed financial services”, contracts “where one or more of the parties to the contract is acting for purposes which are outside a trade, business or profession” or contracts “where none of the parties to the contract has entered into it in the course of carrying on a business in the United Kingdom”. Also, specific exclusions relate to contracts in energy, land, share purchase and business purchase.
Effects of the 2018 Regulations
As mentioned above, any contract terms that prevent, set conditions for, or place restrictions on transferring a receivable are considered invalid and cannot be legally enforced.
In light of this, the assignment of the right to be paid under a contract for the supply of goods (receivables) cannot be restricted or prohibited. However, parties are not prevented from restricting other contracts rights.
Non-assignment clauses can have varying forms. Such clauses are covered by the regulations when terms prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.
Overall, these legislations have had an important impact for businesses involved in the financing of receivables, by facilitating such processes for SMEs.
Digital platforms and fintech solutions: The assignment of receivables has been significantly impacted by the digitisation of financial services. Fintech platforms and online marketplaces have been developed to make the financing and assignment of receivables easier.
These platforms employ tech to assess debtor creditworthiness and provide efficient investor and seller matching, including data analytics and artificial intelligence. They provide businesses more autonomy, transparency, and access to a wider range of possible investors.
Securitisation is an essential part of receivables financing. Asset-backed securities (ABS), a type of financial instrument made up of receivables, are then sold to investors.
Businesses are able to turn their receivables into fast cash by transferring the credit risk and cash flow rights to investors. Investors gain from diversification and potentially greater yields through securitisation, while businesses profit from increased liquidity and risk-reduction capabilities.
https://www.tradefinanceglobal.com/finance-products/accounts-receivables-finance/ – 28/10/2018
https://www.legislation.gov.uk/ukpga/2015/26/section/1/enacted – 28/10/2018
https://www.legislation.gov.uk/ukdsi/2018/9780111171080 – 28/10/2018
https://www.bis.org/publ/bppdf/bispap117.pdf – Accessed 14/06/2023
https://www.investopedia.com/terms/a/asset-backedsecurity.asp – Accessed 14/06/2023
https://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf – Accessed 14/06/2023
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About the Author
Trade Finance Global (TFG) assists companies with raising debt finance. While we can access many traditional forms of finance, we specialise in alternative finance and complex funding solutions related to international trade. We help companies to raise finance in ways that is sometimes out of reach for mainstream lenders.
Contract for the assignment of receivables
A receivable assignment agreement is an agreement by which a creditor – the “assignor” – assigns to another person – the “assignee” – a receivable it holds against a third person – the “assigned debtor”. The assigned debtor is not a party to the assignment agreement. The mere exchange of consents between the assignor and the assignee is sufficient to give rise to the contract for the assignment of the receivable, the consent of the debtor not being necessary for its performance.
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