Why Do Companies Sell Their Receivables?

Accounts receivable (AR) refers to money owed to a business by customers for goods or services delivered but not yet paid for. These are typically recorded as current assets on a company’s balance sheet, representing outstanding invoices. Companies often extend credit, with payment terms typically 30 to 60 days. While waiting for these payments is standard, companies sometimes sell these receivables to a third party. This practice converts outstanding invoices into immediate cash.

Addressing Immediate Cash Needs

Waiting for customers to pay can create significant cash flow gaps for businesses. This is especially true for companies with long payment terms, like net 60 or net 90, or those with high operational costs. For instance, a business might need to cover payroll, purchase new inventory, or pay suppliers before receiving payment for products sold. These timing mismatches can strain daily operations and hinder a company’s ability to meet short-term financial obligations.

Selling receivables provides immediate access to working capital, bridging these financial gaps. Companies can receive an advance of 75% to 95% of the invoice value within 24 hours. This accelerated cash inflow allows them to promptly cover expenses like employee wages, utility bills, or raw material purchases. By converting future income into present liquidity, businesses maintain smooth day-to-day operations and improve overall financial stability.

Transferring Credit Risk

When a business extends credit, it inherently takes on credit risk: the possibility that customers will not pay invoices or will pay them late. This risk can lead to financial losses through bad debt write-offs and introduces uncertainty into financial planning. The percentage of uncollectible accounts varies, but even a small percentage of defaults can affect profitability.

Selling receivables transfers this credit risk to the buyer, often a factor or financier. In a non-recourse arrangement, the factoring company assumes the risk of non-payment if a customer becomes insolvent or files for bankruptcy. This means the selling company is not responsible for repaying the advance if the customer defaults for these reasons. This offloading of risk significantly reduces potential bad debt losses and the administrative burden of pursuing delinquent payments. It is particularly advantageous for companies with a large customer base, international clients, or those in industries with higher default rates, as it mitigates their financial exposure.

Optimizing Business Operations

Managing accounts receivable, including invoicing, tracking payments, and collections, can be a time-consuming and resource-intensive process. This internal management often requires dedicated staff, specialized software, and significant administrative effort. For many businesses, especially smaller ones, these tasks can divert valuable resources away from core activities.

Selling receivables frees up internal resources by outsourcing the collection process to the factoring company. This allows a company to reallocate staff time and efforts toward strategic areas like sales, product development, or service delivery. The reduction in overhead costs associated with maintaining an accounts receivable department can also be substantial. This approach enhances operational efficiency, allowing the business to focus on its primary mission and growth initiatives.

Strategic Financial Management

Selling receivables represents an alternative financing method, distinct from traditional bank loans or lines of credit. Unlike a loan, which adds debt to the balance sheet, a true sale of receivables removes them as an asset and replaces them with cash. This can improve a company’s financial ratios without incurring new debt, making them appear more stable to investors or lenders.

This financial tool can fund various growth initiatives, such as expanding operations, launching new products, or making capital investments. By converting future cash flows into immediate capital, companies gain flexibility in managing their finances and pursuing opportunities. The strategic benefit lies in its ability to provide a flexible and quicker source of capital for business development and improved financial health.