Banking – Accounts Receivable Collateral

Operating Lines of Credit and Letters of Credit


We highly recommend that, if you have not already done so, you read the first article in this series, Banking – Business Loan Application, at :

Everything explained in this article on accounts receivable financing will then fall into place naturally.

As in the other articles in this series on fundamental principles of business banking, we wish to clarify the following facts:

This is not intended to be a detailed accounting or banking course. I have put together the essential information you need in order to give yourself the best chance of succeeding in your business. I shall tell you what your bank manager would like to hear from you at your meetings. I shall tell you the early warning signs that your business needs positive action.

These comments are not for retail business finance, or personal loans; they apply to wholesalers, importers and manufacturers.

To cover the vast amount of banking information, even in thumbnail format, I shall break it down into various segments. Some will apply to your business, others may not. I am intentionally phrasing the segments in very simple layman’s terms. I would advise you to discuss my advice with your accountant, or even your banker, before you decide to act on it.

Let us assume that you make an application to a bank, or other financial institution, for an operating line of credit for your business.

As explained elsewhere in this series on business bank loans, the potential lender will examine various important aspects of the business in order to assess, among other things, the following:

• The viability of the business
• The profitability of the business
• The track record of the business
• The credit history of the business
• The credit history of the owners
• The quality of the collateral
• The adequacy of the collateral

The collateral to cover the operating line of credit usually comprises the following:

• Accounts receivable
• Inventory
• Personal guarantees of the owners
• A floating charge covering any other unencumbered assets

Usually, the most important collateral, as far as the bank is concerned, is the accounts receivable. This article will deal with accounts receivable as collateral for bank financing and will treat the subject from the banker’s point of view, so that you understand what to expect from your lender.

The bank is concerned with the following aspects of the accounts receivable:

• The average size of the individual account. If it is too small, it would not be cost effective for the bank to try and collect delinquent accounts, or to transfer them to a collection agency.

• The mix: If a small number of accounts comprise a large percentage of the total accounts receivable, the danger to the bank is obvious. If any of the large receivables becomes delinquent, a major part of the bank’s coverage is suddenly diminished.

• The credit granting policy of your business. Do you check customers’ credit rating before granting credit to them?

• The quality of the receivables. Are they small unknown businesses or better known? What is their credit rating?

• The accounts receivable turnover rate. Is it within the industry norm? The faster the turnover, obviously the more profitable the business.

• The terms of sale. Do they conform to the industry norms? Any special terms to clear slow-moving inventory?

• Receivables created by consignment sales are not receivables at all, because title does not pass until an invoice is made. And, in consignment sales, the invoice is not made until the customer has, in turn, sold the inventory. The bank will not finance such accounts as being receivables.

• Aging of the receivables: What proportion of the accounts receivable are seriously past due? Usually, depending on the terms of sale, the bank will deduct accounts receivable that are 90 – 120 days old.

• The overall adequacy of the accounts receivable department. Are there strict follow-up procedures in place regarding credit and collection procedures? The bank will usually insist on an aged accounts receivable listing each month to ensure the loan is adequately covered by collateral.

• FACTORING: This needs a little more explanation, which I've attempted here: Very briefly, factoring is a service whereby, for a fee, a factoring company will guarantee that the accounts receivable that they approve will pay what they owe. Typically, a factoring company will offer to become your accounts receivable department. They will process your invoices into aged listings, approve credit lines or specific credits for each receivable, and collect the amount due on your behalf. Their fees depend on whether your business is retail (higher fee) or wholesale, among other criteria.

Essentially, if the account goes bankrupt, the factoring company will pay your business the amount owed. Similarly, if the account is way past due, you can apply to the factoring company to pay the debt. Obviously, this is a huge plus for the bank which is extending your business a line of credit, with the accounts receivable as an integral part of the collateral. The bank will be more inclined to advance a higher percentage of the receivables value if they are guaranteed by a factoring company.

The mechanics of how the bank formulates the operating line of credit for your business depends on various criteria, as explained. Accounts receivable are prime collateral for the bank and, depending on their assessment of the accounts receivable, they may be prepared to advance upto 80% of current receivables. Some finance companies may advance upto 90%, especially if they are factoring and financing institutions who are guaranteeing your business’s receivables.

The above criteria should give you a broad idea as to the importance of accounts receivable collateral to the bank, and how it will analyse them.

After all, a simplistic explanation of the whole idea of obtaining working capital financing, to augment your own contributed capital, is to be able to purchase products, sell them to customers (accounts receivable) at a profit, collect what is due from them (your profit included), and pay your overheads out of the proceeds. The bank line of credit is essentially bridging the financing of your business expenses until the money is collected.

Other segments on business banking cover:

Equity in the business

>Accounts Receivable Collateral
Inventory Collateral
Letters of Credit
Cashflow projections
Banking - Business Loan Applications

Cybernetic Transposition to earn money fast

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