How to Dispose of Receivables
If a company finds that it lacks funds to make payroll or cut a check to pay some other type of expense, the company may prefer to accept a lesser amount for a receivable transaction than try to get a working capital (short-term) loan.
A company can structure disposing of receivables in a variety of ways. The most prevalent are pledging, assignment, and factoring.
You may remember these terms from previous accounting classes but don’t quite remember the difference in the three. Never fear! Here’s a thumbnail sketch of all three:
Pledging: Nope, you’re not applying for fraternity membership. Pledging takes place when the company uses a receivable as security for a loan for which the company is the debtor. When this situation occurs, the company discloses it in the balance sheet parenthetically — as in, Accounts receivable ($500,000 of which has been pledged as collateral for bank loans) — or as a note disclosure.
Assignment: A formal transfer of the debt takes place from one company to another. Often this process is invisible to the debtor. The debtor merrily continues to make payments to the original company, none the wiser. Assigned accounts stay on the balance sheet of the original issuer, with disclosure similar to pledging.
Factoring: Factoring takes place when there’s an outright sale of the receivable to a new owner. Notification goes to the debtor that payments are henceforth to be made to the new owner of the debt.
Sales transactions can be either recourse, which means the seller guarantees payment to the purchaser in case the debtor doesn’t pay, or nonrecourse, which means the seller has no further obligation for collectability.
Current assets are cash or any asset that the company anticipates converting to cash within a 12-month period from the date of the balance sheet. List current assets in order of liquidity on the balance sheet. Because cash is the most liquid (duh, it’s cash!), it shows up on the balance sheet first. Other common current assets are marketable securities, accounts receivable, inventory, prepaid assets, and deferred tax assets.