This is a popular method of financing working capital requirements for growing businesses. Paperwork on these loans are more streamlined when compared to historical requirements. What this type of financing does is it allows a business to take a 'not so liquid asset' and convert it to cash immediately when the merchandise is sold. What it is not intended to do is supplement capital for a grossly undercapitalized firm in a rapid growth period.

The purpose of this type of financing is to provide short-term working funds or permanent capital for growing firms. Sometimes it is used to avoid a periodic cleanup requirement (a period of time specified in the note that the balance must be brought to zero and left unused for usually 30 days of each calendar year) under conventional short-term bank lines of credit. It also provides financing flexibility to rapidly growing firms.

To qualify, a company must have a positive net worth and retained earnings. It must be showing a trend for positive growth and profitability. You must have reasonable leverage on the balance sheet, ranging from 3 to 5 times depending on industry. Your sales volume must be at least $50,000 per month with a potential for increase. Good accounting records are a must and usually must be provided to the lender on a monthly basis. The management team must be very capable and knowledgeable in their respectable industry. Most financial institutions will not accept accounts recievable financing for consigned merchandise, progress billings or other forms of conditional sales where large returns are allowed.

The way it works is there is a daily or weekly assignment, which the borrower chooses, of sales journals and cash reciept journals or invoices as the borrower chooses. The lender is supplied with a monthly aging report of the recievables by invoice date. A reserve is established to protect against delinquent accounts in excess of 90 days. The lender conducts a periodic audit of the company's records to make sure they protect thier existing collateral.

Since ther are various plans available, borrowers can tailor the financing to their particular needs. There is no repayment of the principal balance on this debt. You are billed an a monthly basis for interest only and the loan is repaid by submitting new collateral. The borrower can increase the availability of funds by submitting more collateral (accounts recievable) to the lender. As your collateral base increases, your borrowing capability increases; therefore, the credit, in a sense, is unlimited. This encourages the borrower to utilize good collection practices to reduce interest costs. It also induces you to use bank debt only when you need to and does not encourage large checking account balances with the bank.

The bottom line is this: This financing provides an ideal solution to permanent working capital for a fast growing firm that is unable to supply their working capital needs from the retained earnings.

Learn more about this author, Reginald Auzenne.
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