Are There Foolproof Repayment Plans?
Even when the first four keys have been put in place, there will be occasions when all does not go as expected. Whenever money goes out the door, there is a chance it will not return. While no lender ever makes a decision to fund with the anticipation of loss, circumstances do change, and there must be ways to deal with the changes. This need for total protection leads to the fifth and final key.
Protection against Changing Circumstances
No lender will ever admit to having made factoring Accounts receivable that was bad the day it was funded; rather, the lender will point out that circumstances changed. Any repayment source is inherently subject to the risk of changing credit circumstances. When receivables are the primary repayment source, the bank looks first to payment of the receivables by the account debtors and then to traditional sources of protection, such as cash flow, additional collateral, and personal guaranties.
In receivables purchasing relationships, the bank has significant additional protection in the flexibility to adjust the amount of the business' cash collateral reserve. Receivables that have aged beyond a pre-determined delinquency criterion may be charged out of this reserve account, affecting the repurchase obligation established with the business. Although loan agreements governing lines of credit or asset-based revolvers may contain language allowing the bank to adjust advance rates, most banks rarely reexamine advance rates until a line is up for renewal or already in default.
Another nontraditional source of protection to guard against changing circumstances is accounts receivable insurance. Coverage can be written to cover receivables purchased or pledged as collateral. Several large and reputable insurers, for example, CNA Insurance Company, offer this type of coverage, which has been written for more than a hundred years in this country. While such insurance is not a guaranty of payment under all scenarios, it does ensure that valid receivables will not go unpaid because of account debtor insolvency or simple nonpayment, subject to the terms of the policy. Since fraud is another significant risk inherent in dealing with accounts receivable, fraud insurance is another effective measure of protection. Currently, this unique third-party fraud protection is available only through a receivables purchasing software provider in conjunction with its program. These forms of insurance may never be called on, but they add the extra level of protection that most organizations seek when dealing with accounts receivable. No repayment source is foolproof, and the wisdom of having a secondary source of repayment is indisputable. This is the decade of small business, however, and banks are being called on with increasing frequency to help businesses grow by funding what for many companies is their largest asset - their accounts receivable. By and large, banks are responding to this opportunity by structuring facilities - in the form of either loans or receivables purchases - with significant reliance on the accounts receivable for repayment. These facilities have proved to be exceptionally profitable, but without proper attention to the risks inherent in receivables, banks can be and have been burned. The need for businesses to free cash from their receivables is not going to disappear. The banks most successful at capitalizing on this market opportunity will be those that recognize and control their receivables risk. By incorporating these five keys into the structure of every accounts receivable facility, banks can mitigate much of their risk and take more comfort in the reliability of this important repayment source.
Account Receivables
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