78106_16_Web_Ch16A_p01-06 - WEB EXTENSION 16A Secured...

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WEB EXTENSION 16A Secured Short-Term Financing T his extension discusses procedures for using accounts receivable and invento- ries as security for short-term loans. As noted in the chapter, secured loans in- volve quite a bit of paperwork and other administrative costs, which make them relatively expensive. However, factoring and other forms of accounts receivable financing are heavily used in international finance. Also, secured short-term financing is often the only type of financing available to weaker firms even for purely domestic financial transactions. 16.1 A CCOUNTS R ECEIVABLE F INANCING Accounts receivable financing involves either the pledging of receivables or the sell- ing of receivables (called factoring ). The pledging of accounts receivable , or putting accounts receivable up as security for a loan, is characterized by two features: (1) the lender has a claim against the receivables, and (2) the lender also has recourse to the borrower if the person or firm that bought the goods does not pay, the selling firm must take the loss. Therefore, the risk of default on the pledged accounts receivable remains with the borrower. The buyer of the goods is not ordinarily notified about the pledging of the receivables, and the financial institution that lends on the security of accounts receivable is generally either a commercial bank or one of the large in- dustrial finance companies. Factoring , or selling accounts receivable, involves the purchase of accounts receiv- able by the lender, generally without recourse to the borrower; this means that, if the purchaser of the goods does not pay for them, then the lender (not the seller of the goods) takes the loss. Under factoring, the buyer of the goods is typically notified of the transfer and is asked to make payment directly to the financial institution. Be- cause the factoring firm assumes the risk of default on bad accounts, it makes the credit check on receivable accounts. In this way, factors not only provide money but also serve as a credit department for the borrower. Incidentally, the same financial institutions that make loans against pledged receivables also serve as factors. Thus, depending on the circumstances and wishes of the borrower, a financial institution will provide either form of receivables financing. Procedure for pledging accounts receivable. The financing of accounts receivable is initiated by a legally binding agreement between the seller of the goods and the financing institution. The agreement sets forth in detail the procedures to be followed and the legal obligations of both parties. Once the working relationship has been established, the seller periodically takes a batch of invoices to the fi- nancing institution. The lender reviews the invoices and makes credit appraisals 1
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of the buyers. Invoices of companies that do not meet the lender s credit stan- dards are not accepted for pledging. The financial institution seeks to protect itself at every phase of the operation.
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78106_16_Web_Ch16A_p01-06 - WEB EXTENSION 16A Secured...

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