What is an Assignment of Accounts Receivable?
Assigning accounts receivable is a fairly straightforward business financing option where a company receives a loan using its outstanding invoices as collateral. It is a form of asset-based financing.
In general assignment, the company uses all accounts receivable as collateral. In specific assignment, the borrower only puts up select invoices as collateral.
How does Assigning Accounts Receivable work?
In the accounts receivable assignment process, a company assigns receivables to a lending institution to borrow money. The borrower pays interest plus additional fees.
The borrowing company retains ownership of the accounts receivable and collects payment from its customers. The borrower uses customer payments to repay the loan.
If the borrower fails to repay the loan, the lending institution claims the accounts receivable and collects payment. The transaction is not recorded on financial statements such as the balance sheet but does require journal entries for accurate accounting.
Frequently Asked Questions
Here are the most common questions about assignment of receivables assignment.
What’s the difference between Factoring & Assigning Receivables?
When a business assigns accounts receivables, it retains ownership. Ownership of the accounts receivable only transfers to the lender in the case of a default. This means the borrower must collect from customers and pay off the loan.
Accounts receivable factoring, also called invoice factoring, is the sale of accounts receivable to a lender or factoring company. The factoring company purchases the invoices at a discounted rate and sends a cash advance to the selling company.
The factoring company then collects payment from the selling company’s customers. Invoice factoring is not a loan but a cash advance for purchasing receivables.
What are the benefits of Assigning Receivables?
Assigning receivables turns unpaid invoices into immediate working capital. The borrowing business can then cover day-to-day expenses like payroll or rent.
The borrowing company still owns the accounts, but the assigned receivables serve as collateral. Customers won’t know the business put their accounts up for assignment unless the company defaults and the lender collects payment.
What are the drawbacks of Assigning Receivables?
Assigning receivables is an expensive way to borrow money. As a form of near-term financing, businesses typically pay off the loan within several months. But the interest rates are sometimes comparable to a 100% APR. Companies usually only use AR assignment when they can’t get other forms of financing but need working capital to sustain the business during rapid growth.
Any form of business financing comes with risk. If a company assigns receivables and defaults on the loan, ownership of the assets transfers to the lender.
Assignment Pros & Cons:
- A viable option when a business can’t secure other loans.
- Assigned receivables serve as collateral.
- Converts unpaid invoices into working capital.
- Rates and fees run high, making assignment an expensive way to borrow.
- Putting receivables up as collateral risks losing the assets.
Assignment of Accounts Receivable – Final Thoughts
Assigning receivables is best for small businesses that growing rapidly and need working capital but can’t qualify for traditional loans. It carries high-interest rates, but the cost could be worth it if it keeps your business afloat.