There’s a common temptation in business to hold on to aging receivables with the belief that payment is just one more email or phone-call away. However, that’s not always the case, and the longer those aging receivables stay on the books, the harder they become to recover. One of the obvious benefits of selling non-performing accounts is increased liquidity for the creditor– the funds previously MIA as a result of non-paying customers are now available to fuel other business operations.
But of course, there will be various considerations when making this kind of decision. Jefferson Capital reviews below how to determine if selling receivables makes sense for your business.
What Are Account Receivables?
The first step to knowing whether or not a business is ready to sell account receivables is simply understanding what counts as an account receivable. An account receivable is the result of an extension credit representing the borrower’s promise to repay the creditor for the credit that was extended for the purchase of goods or services. For example, if a bank issues a credit card to a consumer and the consumer incurs $100.00 worth of charges on the credit card account, the $100.00 due on the account is listed as an “account receivable” in the bank’s records. It will remain there until the amount is paid off by the consumer. Essentially, a receivable is a customer’s promise to repay borrowed funds. Account receivables are assets that can be purchased and sold just like any other asset. The ability to buy and sell account receivables creates significant benefits to both the business and consumer.
What is the Account Receivables Secondary Market?
The secondary market for account receivables (also referred to as the “debt buying” industry) provides for the orderly purchase and sale of account receivables. The receivables secondary market is the marketplace where ownership of performing and nonper¬forming account receivables (i.e. the asset) are purchased by companies that were not a party to the original transaction. The selling entity on the secondary market may be the original creditor or a company that purchased the receivable from another debt buying company. When a transaction is completed in the secondary market, the ownership of the receivable and all legal rights associated with that asset are now held by a company not a party to the original transaction.
What are the Benefits of the Account Receivables Secondary Market?
The account receivables secondary market creates significant benefits for both creditors and consumers.
For consumers, the secondary market:
- Allows credit to be widely available -The United States’ economy is heavily reliant on the extension of credit for the purchase of goods and services. Busi¬nesses calculate into the price of goods and services the anticipated losses from nonperforming receivables. The secondary market provides a mechanism for reducing those losses, which is factored into the business’ pricing calculation. If a business is unable to recover its receivables, the cost of their goods and services will increase and the business may be forced to restrict the exten¬sion of credit to only low risk consumers.
- Lower Cost Settlements -Debt buyers who purchase accounts are often willing to negotiate settlements of accounts for less than the original creditor since the debt buyer purchased the account for less than the full balance.
For businesses, the secondary market:
- Facilitates liquidity for lending entities -The money lenders receive from debt buyers on the secondary market allows those lenders to use fresh capital to issue new loans. Without the secondary market, lenders would have less access to capital which would restrict their ability to loan to new borrowers.
- Creates small business jobs – The debt buying and collections industries account for hundreds of thousands of jobs nationwide, the majority of which are with small businesses. Without a viable secondary market, many of the jobs created in the debt buying industry would either not exist or would remain with large lending entities.
- Allows creditors to focus on their core competencies -Debt collection is usually not considered a main focus of an originating creditor’s business model. By selling its accounts receivables, an originating creditor can focus its energies and capital on what it does best.
Ways to Tell if Selling Receivables Makes Sense for a Business
In light of the above referenced benefits of the account receivables secondary market, selling receivables is part of many successful businesses’ standard operating procedure.
Below are three ways to tell if selling receivables makes sense for a business:
- The Business Has Significant Unpaid Account Receivables –If a business has a large portfolio of account receivables on its books, selling the receivables may make sense for that business. Because of the transaction costs of selling and purchasing receivables, most debt buyers are not interested in purchasing only a few accounts at a time. However, what constitutes a “significant” amount of receivables is dependent on each segment of the secondary market and a debt buyers’ willingness to purchase the accounts.
- The Business’ Capital Needs – If a business is in need of fresh capital, the selling of receivables for present value is a good alternative to waiting for a long term collections cycle to be completed.
- Satisfying Compliance Obligations – Creditors must partner with reputable debt purchasers to satisfy reputational concerns and regulatory requirements. As part of those obligations, creditors must vet potential purchasers of the accounts to ensure the debt buyer complies with all collection laws and obligations. The creditor must also provide sufficient documentation of the account to the debt buyer to fulfill the debt buyer’s obligation to establish the amount owed and its ownership of the account.
The receivables secondary market provides direct and tangible benefits to many successful businesses. It also benefits consumers by providing liquidity to lenders who are able to issue new loans. Businesses holding a large volume of account receivables on their books should investigate the value-add proposition of partnering with a reputable debt purchaser.