Assignment of Accounts Receivable
Assignment of accounts receivable is a financing arrangement in which a company uses its accounts receivable as collateral to obtain a loan or financing from a financial institution or a lender. In this arrangement, the company “assigns” or transfers the rights to collect payments from the outstanding accounts receivable to the lender.
The lender then provides the company with a percentage of the assigned accounts receivable value as a loan, while retaining a portion as collateral or to cover potential defaults. The company is still responsible for collecting payments from its customers. When the customers make payments, the company forwards the collected amount to the lender, who applies the payment to the outstanding loan balance.
The assignment of accounts receivable is a common financing option for businesses with cash flow constraints or those that need immediate funding for working capital requirements or other short-term financial needs.
Example of the Assignment of Accounts Receivable
Let’s consider a fictional company, ABC Corp., that manufactures and sells electronics. ABC Corp. has $200,000 worth of outstanding accounts receivable, but it needs immediate cash to purchase raw materials and pay its employees.
ABC Corp. approaches XYZ Bank to obtain financing using its accounts receivable as collateral. XYZ Bank agrees to provide a loan of 85% of the total accounts receivable value, which amounts to $170,000 (85% of $200,000).
In this arrangement, ABC Corp. assigns the accounts receivable to XYZ Bank, and XYZ Bank provides the company with $170,000 in financing. ABC Corp. remains responsible for collecting payments from its customers.
As customers of ABC Corp. pay their invoices, the company forwards the collected payments to XYZ Bank. XYZ Bank then applies these payments to reduce the outstanding loan balance. Once all the outstanding invoices are collected and the loan balance is paid off, the assignment of accounts receivable is considered complete.
This arrangement allows ABC Corp. to obtain the immediate cash it needs to continue its business operations, while XYZ Bank takes on the risk associated with the accounts receivable collection process.