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3 Ways to Use Accounts Receivable as Collateral

Topics: Finance, Accounts Receivable

It can be difficult for businesses that need working capital to purchase equipment, hire employees or grow. One of the toughest jobs a business owner can face is finding a business loan. Due to the high risks in most businesses, few banks will extend bank loans to them, particularly those who have been in business under a certain amount of time, or who have credit issues or cash flow problems.

However, these businesses still have financing options. One common option is to use your accounts receivables as collateral for a short term or long term loan, or a line of credit. Using accounts receivables as collateral shows lenders that a business has sufficient incoming cash flow to repay a loan.

Accounts Receivables As Assets?

Accounts receivables are essentially a company’s incoming cash from paid invoices and sales transactions; therefore, they are treated as an asset. One of the many accounting tools available is to use a company’s accounts receivables as collateral for a loan or a line of credit.

This strategy is also commonly referred to as pledging in the accounting world, and is one that is used by many companies that do not have physical equipment or assets. However, one caveat is that when accounts receivables are used as collateral, the lender typically limits the amount of the loan to a percentage of the total amount of accounts receivables, or a percentage of the total amount based on the age of receivables.

For example, a lender may not permit a company to use accounts receivables that are 90 days old. The lender may also exclude any receivables that the company have granted longer payment terms for. The lender will likely request a copy of the accounts receivable aging report to analyze and trace details.

If a lender chooses to allow a company to use accounts receivables as an asset for collateral, the the company is still responsible for collecting the outstanding receivables. Companies are not required to notify customers of any pledging arrangement.

Finally, over the course of the pledging agreement, the lender will monitor the amount of collateral available, and whether it needs to be adjusted. If the amount of debt outstanding exceeds the amount of accounts receivables, then the borrowing company is responsible for paying this amount to the lender.

In the end, the lender's main concern is the lender, and they're going to be protecting themselves from granting a loan to a company based on accounts receivables that may never be settled.

Ways to Use Accounts Receivables As Collateral

  1. Secured vs. Unsecured Loans - A business loan that uses a company’s accounts receivables as collateral is referred to as a secured loan. Secured loans differ from unsecured loans because unsecured loans do not require collateral for issuing a loan to a company. Secured loans often come with a higher interest rate than unsecured loans.
  2. Duration of Loan - A business may pledge all or only a portion of their account receivables for a specified period of time. The length of time or duration of the loan or agreement is set agreed upon between the company and the lender and all details are specified in the loan terms and conditions.
  3. Regular Payments - As a company pays off a loan, a company may want to work with a lender to reduce the amount of receivables used as collateral for the loan. Most lenders will accommodate this as long as the borrowing company continues to make regular agreed-upon payments.

Accounts receivables as collateral for a loan is a common practice utilized by many businesses that require additional capital. The lender will review a company’s financial statements, cash flow, and other information in order to determine the company’s overall risk level.

How to Show Accounts Receivable as Collateral on a Report

Now that you understand more about how accounts receivables can be used as collateral, and how most lenders treat this particular arrangement, here are some ways to show accounts receivables as collateral on reports.

  1. Total accounts receivable balance. This report should also include the amount of collateral in the “assets” section of the balance sheet. Be sure to exclude any and all doubtful accounts. Doubtful accounts are those accounts that likely will be noncollectable.
  2. Notes and Descriptions. When providing your report to your lender, be sure to also include a note in the accounts receivable account stating that X amount of accounts receivables are used as collateral.
  3. Liabilities. Depending on the amount of time granted for the loan or line of credit—whether short term or long term—be sure to report the collateral in the right liabilities section.

For example, if you think it may take longer than a few months or even six months to pay back a loan, then be sure to accurately report the amount of accounts receivables in the long-term liabilities section of your report. Again, be sure to includes notes in the descriptions in your report where possible.

Using accounts receivables as assets for collateral for a loan or line of credit is a viable financial option for businesses. Ultimately, accounts receivables represent healthy cash flow, which is necessary for securing a loan or line of credit.

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