assignment accounts receivable definition

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Assignment of Accounts Receivable: Meaning, Considerations

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

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What Is Assignment of Accounts Receivable?

Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.

The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.

Key Takeaways

• Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
• This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
• Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
• Accounts receivable are considered to be liquid assets.
• If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.

Understanding Assignment of Accounts Receivable

With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .

An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.

New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.

Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.​

Special Considerations

Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.

Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.

The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.

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Understanding Accounts Receivable (Definition and Examples)

Nick Zaryzcki

Reviewed by

Janet Berry-Johnson, CPA

May 1, 2024

This article is Tax Professional approved

Most small businesses sell to their customers on credit. That is, they deliver the goods and services immediately, send an invoice, then get paid a few weeks later. Businesses keep track of all the money their customers owe them using an account in their books called accounts receivable.

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Here we’ll go over how accounts receivable works, how it’s different from accounts payable , and how properly managing your accounts receivable can get you paid faster.

What is accounts receivable?

Accounts receivable is any amount of money your customers owe you for goods or services they purchased from you in the past. This money is typically collected after a few weeks and is recorded as an asset on your company’s balance sheet. You use accounts receivable as part of accrual basis accounting.

Why is accounts receivable important?

Having lots of customers is great. But if some of them pay late or not at all, they might be hurting your business. Late payments from customers are one of the top reasons why companies get into cash flow or liquidity problems.

When you have a system to manage your working capital , you can stay ahead of issues like these. Calculating your business’s accounts receivable turnover ratio is one of the best ways to keep track of late payments and make sure they aren’t getting out of hand.

How are accounts receivable classified and where do I find my AR balance?

You can find your accounts receivable balance under the ‘current assets’ section on your balance sheet or general ledger . Accounts receivable are classified as an asset because they provide value to your company. (In this case, in the form of a future cash payment.)

Your general ledger will show your total accounts receivable balance, but to dig into outstanding payments by individual customers, you’ll usually need to refer to the accounts receivable subsidiary ledger.

Does accounts receivable count as revenue?

Accounts receivable is an asset account, not a revenue account. However, under accrual accounting , you record revenue at the same time that you record an account receivable.

Let’s say you send your friend Keith’s business, Keith’s Furniture Inc., an invoice for $500 in exchange for a logo you designed for them. You’d make the following entry in your books the moment you invoice Keith’s Furniture:

(If you want to understand why we’re making two entries to record one transaction here, check out our guide to double-entry accounting .)

But remember: under cash basis accounting , there are no accounts receivable. Under that system, a transaction doesn’t count as a sale until the money hits your bank account.

What is an accounts receivable aging schedule?

Keeping track of exactly who’s behind on which payments can get tricky if you have many different customers. Some businesses will create an accounts receivable aging schedule to solve this problem.

Here’s an example of an accounts receivable aging schedule for the fictional company XYZ Inc.

Accounts Receivable Aging Schedule

XYZ Inc., as of July 22, 2021

A quick glance at this schedule can tell us who’s on track to pay within 30 days, who’s behind schedule, and who’s really behind.

For example, you can immediately see that Keith’s Furniture Inc. is having problems paying its bills on time. You might want to give them a call and talk to them about getting their payments back on track.

What’s the difference between accounts receivable and accounts payable?

Though lenders and investors consider both of these metrics when assessing the financial health of your business, they’re not the same.

Accounts receivable are an asset account, representing money that your customers owe you.

Accounts payable on the other hand are a liability account, representing money that you owe another business.

Let’s say you send your friend Keith’s business, Keith’s Furniture Inc., an invoice for $500 in exchange for a logo you designed for them.

When Keith gets your invoice, he’ll record it as an accounts payable in his general ledger, because it’s money he has to pay someone else.

You (or your bookkeeper) record it as an account receivable on your end, because it represents money you will receive from someone else.

What is the “allowance for uncollectible accounts” account?

If you do business long enough, you’ll eventually come across clients who pay late, or not at all. When a client doesn’t pay and we can’t collect their receivables, we call that a bad debt .

Businesses that have been around for a while will often estimate their total bad debts ahead of time to make sure the accounts receivable shown on their financial statements aren’t unrealistically high. They’ll do this by setting up something called an “allowance for uncollectible accounts.”

Let’s say your total sales for the year are expected to be $120,000, and you’ve found that in a typical year, you won’t collect 5% of accounts receivable.

To estimate your bad debts for the year, you could multiply total sales by 5% ($120,000 * 0.05). You’d then credit the resulting amount ($6,000) to “allowance for uncollectible accounts,” and debit “ bad debt expense ” by the same amount:

What is the accounts receivable turnover ratio?

The accounts receivable turnover ratio is a simple financial calculation that shows you how fast your customers are at paying their bills.

We calculate it by dividing total net sales by average accounts receivable.

Let’s use a fictional company XYZ Inc.’s 2021 financials as an example.

Let’s say that at the beginning of 2021 (Jan 1), XYZ Inc. had total accounts receivable of $2,500. Let’s also say that at the end of 2021 (Dec 31) its total accounts receivable was $1,500. It also had total net sales of exactly $60,000 for 2021.

To get the average accounts receivable for XYZ Inc. for that year, we add the beginning and ending accounts receivable amounts and divide them by two:

$2,500 + $1,500 / 2 = $2,000

To calculate the accounts receivable turnover ratio, we then divide net sales ($60,000) by average accounts receivable ($2,000):

$60,000 / $2,000 = 30

This means XYZ Inc. has an accounts receivable turnover ratio of 30. The higher this ratio is, the faster your customers are paying you.

Thirty is a really good accounts receivable turnover ratio. For comparison, in the fourth quarter of 2021 Apple Inc. had a turnover ratio of 13.2.

To calculate the average sales credit period—the average time that it takes for your customers to pay you—we divide 52 (the number of weeks in one year) by the accounts receivable turnover ratio (30):

52 weeks / 30 = 1.73 weeks

This means that in 2021, it took XYZ Inc.’s customers an average of 1.73 weeks to pay their bills. Pretty good!

What can I do to make people pay faster?

Following up on late customer payments can be stressful and time-consuming, but tackling the problem early can save you loads of trouble down the road. Here’s how you can encourage customers to pay you on time.

Develop a crystal-clear credit policy

Instead of getting more flexible with your customers, which can be tempting when you’re starved for cash, develop crystal-clear guidelines for when you can and cannot extend credit to your customers. Then don’t hesitate to enforce them, even if it means turning down a few people in the short term.

Vet new customers, ask for up-front deposits on large orders, and institute interest charges for payments that come in after the due date. When a new customer signs up and sees these payment terms, they’ll understand from the get-go you’re serious about getting paid.

Give customers more ways to pay

If you only offer limited payment options, customers may be more inclined to drag their feet when the invoice due date rolls around. There are fees associated with accepting credit card payments, but allowing customers to pay using their credit cards is usually win-win: you’ll get paid faster and they can rack up points.

Offer a financial incentive

One way to get people to pay you sooner is to make it worth their while. Offering them a discount for paying their invoices early—2% off if you pay within 15 days, for example—can get you paid faster and decrease your customer’s costs. If you don’t already charge a late fee for past due payments, it may be time to consider adding one.

Call them and schedule regular reminders

Simply getting on the phone with a client and reminding them about unpaid invoices can often be enough to get them to pay. Sending email reminders at regular intervals—say, after 15, 30, 45, and 60 days—can also help jog your customers’ memory.

What if they don’t pay?

Let’s say you’ve done all of the above and those outstanding invoices remain unpaid. What now?

Cut off late-paying customers

Many companies will stop delivering services or goods to a customer if they have bills that are more than 120, 90, or even 60 days due. Cutting a customer off in this way can signal that you’re serious about getting paid.

Convert their account receivable into a long-term note

If you have a good relationship with the late-paying customer, you might consider converting their account receivable into a long-term note. In this situation, you replace the account receivable on your books with a loan that is due in more than 12 months and which you charge the customer interest for.

Hire a collection agency

If you can’t contact your customer and are convinced you’ve done everything you can to collect, you can hire someone else to do it for you.

Before deciding whether or not to hire a collector, contact the customer and give them one last chance to make their payment. Collection agencies often take a huge cut of the collectible amount—sometimes as much as 50 percent—and are usually only worth hiring to recover large unpaid bills. Coming to some kind of agreement with the customer is almost always the less time-consuming, less expensive option.

When an account receivable becomes bad debt

When it’s clear that an account receivable won’t get paid, we have to write it off as a bad debt expense.

For example, let’s say that after a few months of waiting, calling him on his cellphone, and talking to his family members, it becomes clear that Keith has disappeared and isn’t going to pay that $500 invoice you sent him.

In this case, you’d debit “allowance for uncollectible accounts” for $500 to decrease it by $500.

Remember that the allowance for uncollectible accounts is just an estimate of how much you won’t collect from your customers. Once it becomes clear that a specific customer won’t pay, there’s no longer any ambiguity about who won’t pay.

Once you’re done adjusting uncollectible accounts, you’d then credit “accounts receivable—Keith’s Furniture Inc.” by $500, also decreasing it by $500. Because we’ve decided that the invoice you sent Keith is uncollectible, he no longer owes you that $500.

So the resulting journal entry would be:

What if they end up paying me after all?

Let’s say a few more months pass, and a mysterious envelope with no return address appears in your mailbox. It’s a cheque from Keith’s Furniture Inc. for $500—he ended up paying you after all!

To record this transaction, you’d first debit “accounts receivable—Keith’s Furniture Inc.” by $500 again to get the receivable back on your books, and then credit revenue by $500.

Finally, to record the cash payment, you’d debit your “cash” account by $500, and credit “accounts receivable—Keith’s Furniture Inc.” by $500 again to close it out once and for all.

Accounts receivable as a standard for GAAP & IFRS

According to the industry standard rules for accounting, Generally Accepted Accounting Practices (GAAP), the accounts receivable balance should equal net realizable value, which is the amount of cash a business expects to collect from customers. Therefore, this balance would not include bad debt.

According to International Financial Reporting Standards (IFRS), which are used in Canada, the European Union, most of South American, Australia, and many other countries around the world, your accounts receivable would apply to any funds you expect to collect from customers within one year (current debt, in other words).

When to call something ‘bad debt’

If the costs of collecting the debt start approaching the total value of the debt itself, it might be time to start thinking about writing the debt off as bad debt—that is, debt that is no longer of value to you. Bad debt can also result from a customer going bankrupt and being financially incapable of paying back their debts.

The IRS says that bad debts include “loans to clients and suppliers,” “credit sales to customers,” and “business loan guarantees,” and that a business "deducts its bad debts, in full or in part, from gross income when figuring its taxable income .”

The IRS’s Business Expenses guide provides detailed information about which kinds of bad debt you can write off on your taxes.

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Assignment of Accounts Receivable Journal Entries

The assignment of accounts receivable journal entries below act as a quick reference, and set out the most commonly encountered situations when dealing with the double entry posting of accounts receivable assignment.

The assignment of accounts receivable journal entries are based on the following information:

• Accounts receivable 50,000 on 45 days terms
• Assignment fee of 1% (500)
• Initial advance of 80% (40,000)
• Cash received from customers 6,000
• Interest on advances at 9%, outstanding on average for 40 days (40,000 x 9% x 40 / 365 = 395)

About the Author

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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Assignment of Accounts Receivable

The financial accounting term assignment of accounts receivable refers to the process whereby a company borrows cash from a lender, and uses the receivable as collateral on the loan. When accounts receivable is assigned, the terms of the agreement should be noted in the company's financial statements.

Explanation

In the normal course of business, customers are constantly making purchases on credit and remitting payments. Transferring receivables to another party allows companies to reduce the sales to cash revenue cycle time. Also known as pledging, assignment of accounts receivable is one of two ways companies dispose of receivables, the other being factoring.

The assignment process involves an agreement with a lending institution, and the creation of a promissory note that pledges a portion of the company's accounts receivable as collateral on the loan. If the company does not fulfill its obligation under the agreement, the lender has a right to collect the receivables. There are two ways this can be accomplished:

General Assignment : a portion of, or all, receivables owned by the company are pledged as collateral. The only transaction recorded by the company is a credit to cash and a debit to notes payable. If material, the terms of the agreement should also appear in the notes to the company's financial statements.

Specific Assignment : the lender and borrower enter into an agreement that identifies specific accounts to be used as collateral. The two parties will also outline who will attempt to collect the receivable, and whether or not the debtor will be notified.

In the case of specific assignment, if the company and lender agree the lending institution will collect the receivables, the debtor will be instructed to remit payment directly to the lender.

The journal entries for general assignments are fairly straightforward. In the example below, Company A records the receipt of a $100,000 loan collateralized using accounts receivable, and the creation of notes payable for $100,000.

In specific assignments, the entries are more complex since the receivable includes accounts that are explicitly identified. In this case, Company A has pledged $200,000 of accounts in exchange for a loan of $100,000.

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Assignment of Accounts Receivable

The Assignment of Accounts Receivable refers to the legal transfer of rights and claims associated with a company’s outstanding invoices or accounts receivable to a third party. Also known as accounts receivable financing or factoring, this financial transaction enables a business to gain immediate access to cash by selling its unpaid invoices to a specialized financial institution called a factor.

In this process, the company, known as the assignor, sells its accounts receivable at a discount to the factor, known as the assignee. The factor assumes the responsibility for collecting the amounts owed by the customers of the assignor. In return, the assignor receives an upfront payment from the factor, generally representing a percentage of the total value of the assigned accounts receivable.

The Assignment of Accounts Receivable offers several benefits to businesses. Firstly, it provides a quick and efficient way to convert accounts receivable into operating cash, bypassing the usual waiting period for payment from customers. This accelerated access to capital can help companies cover immediate expenses, fund growth initiatives, or address short-term financial obligations. Additionally, the assignor can reduce the administrative burden associated with collections and focus on core business operations, while the factor assumes the responsibility for credit management and debt recovery.

Furthermore, the Assignment of Accounts Receivable can help alleviate the risk of bad debts for the assignor. By transferring the risk of non-payment to the factor, the company can protect itself from potential losses arising from customer defaults or bankruptcies. This transfer of risk is often accompanied by the factor’s provision of credit analysis and assessment services, minimizing the likelihood of taking on customers with poor creditworthiness.

From the perspective of the assignee, the Assignment of Accounts Receivable presents an opportunity for investment. Factors operate by purchasing the assigned accounts receivable at a discount and subsequently collecting the full value from the customers. The difference between the discounted purchase price and the collected amount becomes the factor’s profit. Factors assume some amount of risk, as the ultimate collection depends on the creditworthiness and payment practices of the assignor’s customers. However, the factor’s expertise in credit analysis and debt recovery strategies helps mitigate these risks.

It is important to note that the Assignment of Accounts Receivable is typically considered a form of off-balance sheet financing. This means that the assignor can remove the assigned invoices from its books, potentially improving its financial ratios and overall financial position. However, the assignor is sometimes required to disclose the assignment arrangement in its financial statements, highlighting the impact on its cash flows and potential contingent liabilities.

In summary, the Assignment of Accounts Receivable is a financial arrangement enabling businesses to convert their outstanding invoices into immediate cash by selling them to a third party, known as a factor. This transaction provides various benefits, including improved cash flow, reduced administrative burden, and protection against bad debts. Factors, in turn, capitalize on the opportunity by acquiring the accounts receivable at a discount and assuming the responsibility of collections. Overall, the Assignment of Accounts Receivable serves as a valuable tool for managing cash flow and optimizing working capital in business finance and accounting practices.

The Difference Between Assignment of Receivables & Factoring of Receivables

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You can raise cash fast by assigning your business accounts receivables or factoring your receivables. Assigning and factoring accounts receivables are popular because they provide off-balance sheet financing. The transaction normally does not appear in your financial statements and your customers may never know their accounts were assigned or factored. However, the differences between assigning and factoring receivables can impact your future cash flows and profits.

How Receivables Assignment Works

Assigning your accounts receivables means that you use them as collateral for a secured loan. The financial institution, such as a bank or loan company, analyzes the accounts receivable aging report. For each invoice that qualifies, you will likely receive 70 to 90 percent of the outstanding balance in cash, according to All Business . Depending on the lender, you may have to assign all your receivables or specific receivables to secure the loan. Once you have repaid the loan, you can use the accounts as collateral for a new loan.

Assignment Strengths and Weaknesses

Using your receivables as collateral lets you retain ownership of the accounts as long as you make your payments on time, says Accounting Coach. Since the lender deals directly with you, your customers never know that you have borrowed against their outstanding accounts. However, lenders charge high fees and interest on an assignment of accounts receivable loan. A loan made with recourse means that you still are responsible for repaying the loan if your customer defaults on their payments. You will lose ownership of your accounts if you do not repay the loan per the agreement terms.

How Factoring Receivables Works

When you factor your accounts receivable, you sell them to a financial institution or a company that specializes in purchasing accounts receivables. The factor analyzes your accounts receivable aging report to see which accounts meet their purchase criteria. Some factors will not purchase receivables that are delinquent 45 days or longer. Factors pay anywhere from 65 percent to 90 percent of an invoice’s value. Once you factor an account, the factor takes ownership of the invoices.

Factoring Strengths and Weaknesses

Factoring your accounts receivables gives you instant cash and puts the burden of collecting payment from slow or non-paying customers on the factor. If you sell the accounts without recourse, the factor cannot look to you for payment should your former customers default on the payments. On the other hand, factoring your receivables could result in your losing customers if they assume you sold their accounts because of financial problems. In addition, factoring receivables is expensive. Factors charge high fees and may retain recourse rights while paying you a fraction of your receivables' full value.

• All Business: The Difference Between Factoring and Accounts Receivable Financing

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Account Receivables

• First Online: 04 November 2018

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Receivable is a general term which refers to all monetary obligations owed to the business by its customers or debtors. As long as a business expects to recover the money from the debtors, it records its receivables as assets in its balance sheet because it expects to derive future benefits from them. It does not matter whether they are due in the current period or not.

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Lessambo, F.I. (2018). Account Receivables. In: Financial Statements. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-99984-5_4

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Accounts Receivable (AR) Explained

Accounts receivable are cash amounts that clients owe your company. The goods or services have been delivered and the invoice sent. Now, it’s just a matter of time before you receive payment for a job well done.

If you’ve vetted your customers well and delivered the invoice properly, the money due will flow in as agreed with little or no further action on your part until it’s time to record payments. However, no matter how efficiently you managed the process of extending credit, you may find yourself mired in collection activities. Late payments or non-payments from customers can cause cash flow problems and lead to difficulty obtaining loans and courting investors. That’s why you need to master the AR process.

Video: AP vs. AR

What is Accounts Receivable?

Accounts receivable (AR) represent the amount of money that customers owe your company for products or services that have been delivered. AR are listed on the balance sheet as current assets and also refer to invoices that clients owe for items or work performed for them on credit.

Key Takeaways

• Accounts receivable are a current asset on the balance sheet.
• Accounts receivable represent money a company has invoiced for goods or services that have been delivered but not yet paid for.
• Accounts receivable are the flip side of accounts payable, which is money that a company owes to another business for products or services received.

Accounts Receivable Explained

Most businesses provide goods or services before they invoice their clients. The money owed in such a case is called an account receivable. The funds due are recorded as a current asset to offer insight into the financial condition of the company. In accrual-based accounting, AR represents value to the company, even though the money has not come into the company’s possession yet. Accrual-basis accounting recognizes income when it is earned rather than waiting for receipt of payment, as in cash-basis accounting.

Generally speaking, when both parties honor the terms of the transaction, the AR translates into bankable cash. If there is a delay in a reciveable accounts conversion into payment on the customer side of the transaction, the value of the AR may deteriorate.

While invoices are sometimes lost or misdirected, financial instability, up to and including pre-bankruptcy conditions, is a large reason for customer late payments or defaults—and some companies simply have inefficient process for paying their invoices. This can lead to expensive collection activities and is also why some “pay later” transactions may require credit checks and other risk-mitigation efforts ahead of delivery of goods and services. Payment delays and AR value deterioration typically continue if collection activities are not promptly executed.

Accounts Payable versus Accounts Receivable

Accounts payable and accounts receivable are two sides of the same coin: Accounts payable represent money that a company owes to a supplier for goods or services purchased. Accounts receivable, in contrast, represent money coming in as payment for goods or services delivered with payment terms. AP is considered a liability, and AR is an asset.

For example, if a company orders 50 reams of paper and receives a bill for $300, it would record that expenditure under accounts payable. The office supply company would record the $300 under accounts receivable because it is money the business will receive.

For a company to weather some missed or late payments, it needs a healthy ratio of AR to AP. Typically, a 1:1 AR/AP ratio means that you have just enough money coming in from accounts receivable to cover your expenses. A 1:1 ratio is a risky cash flow scenario because if a client does not pay as agreed, you can’t cover your own bills. This can initiate a spiral of increasing expenses due to late fees or an inability to operate because you can’t pay employees. A healthy business typically has an AR/AP ratio closer to 2:1. At 3:1, there is usually room for savings or reinvestment into the company.

Types of Accounts Receivable

Subcategories of accounts receivable can be divided by specific client accounts or to distinguish between types of goods and services. Some businesses also choose to split accounts receivable based on whether the promise to pay was an oral or written agreement. Accounts receivable are part of a larger group of receivables that also include notes receivable and other receivables such as rent receivables, loans, term deposits and more. There are many types of receivables to account for a vast array of industries and circumstances.

• Notes receivable are are amounts your customer owes after signing a formal promissory notes to acknowledge the debt.
• Companies in housing or commercial real estate track rent receivables, which are amounts owed by tenants, typically on a monthly basis.
• Any loans to employees or other businesses result in loan receivables.
• If anyone owes your business interest as part of a payment plan, your accountant would record that amount as an interest receivable.

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Accounts Receivable Payment Terms

Accounts receivable payment terms refer to the date by which the customer agrees to remit payment. The most common payment term is net30, which means the customer agrees to pay the full amount of the invoice within 30 days. The typical range for payment terms is a few days to up to a full year. As customers, some large businesses will insist on net60 or even net90 terms.

Longer payment terms can put a small supplier in a tight spot if it is depending on that money to pay for overhead and other expenses. Cash flow management—control over how much money is coming or going—is one of the most significant factors in the success or failure of a company.

Why Is Accounts Receivable Important?

Since AR plays such an important role in cash flow management, maintaining an accurate record of accounts receivable is vital for understanding the liquidity of a company as well as its overall financial condition. Credit issuers and potential investors look closely at accounts receivable for financing decisions.

Accounts receivable financing is an arrangement that offers funding based on a portion of accounts receivable. Sloppy AR records could result in difficulty securing accounts receivable financing or a loss of confidence from potential investors.

Accounts Receivable (AR) Benefits

In accrual-based accounting, recording accounts receivable is critical to maintaining an accurate picture of a company’s assets on its balance sheet. Poor invoicing practices and AR records could lead to misunderstandings about your company’s cash position, which, in turn, could pose problems in paying expenses, misallocation of funds, audits, and difficulty securing financing or investors.

Accounts Receivable Workflow

To create a workflow for accounts receivable, a business must generate and send a bill to the customer. Depending on whether the client makes a timely payment, the company may apply discounts or fees as applicable.

After payment is received, it is recorded as a deposit. If payment is not received, the company may send another invoice to reflect the new balance with late fees.

If the client still does not pay, the business must determine whether the client can or will pay to decide whether to write off the sale or apply additional fees and invoice again. Late fees of 1% to 1.5% are standard. Legal limits for the maximum amount of fees and interest that may be charged vary between states. If you stay below 10% of the balance due per year, you are unlikely to run afoul of the law.

How to Record Accounts Receivable

Accounts receivable are listed as a current asset on the balance sheet and included on the income statement as a sale or revenue—just the same as goods or services that were paid for immediately. Some accounting software will automatically compute accounts receivable as the user creates client invoices.

Funds that have been earned but not collected are accruals, so accounts receivable are recorded in accrual accounting. In cash accounting, the transaction would not be recorded until the client paid.

Accounts Receivable Examples

If Bob’s Plumbing Service visited a client’s office to repair a leak and invoiced the client for that service, Bob’s accountant would record the amount owed as an account receivable on Bob’s balance sheet.

As another example, Susie’s Catering Service delivers 100 box lunches to a recurring monthly company luncheon. Each month, Susie’s company records the total due under accounts receivable after she delivers the goods to her client.

What is the Accounts Receivable Process?

Essentially, the accounts receivable process begins with a purchase agreement where terms are set between a client and the company providing goods or services. Then, an invoice is issued, and the account receivable is recorded.

When the account is paid as agreed, it is recorded as a deposit and is no longer a receivable. If the account is not paid according to the terms of the agreement, the company begins a collections process.

Steps in The Accounts Receivable Process

• Deliver goods or services to your client.
• Invoice the customer.
• Record the invoiced amount as an account receivable.
• If the client pays as agreed, record the payment as a deposit. The account is no longer receivable.
• If the customer fails to pay, issue another invoice with any penalties as agreed at the time of delivery.

What is the Accounts Receivable Turnover Ratio?

The accounts receivable turnover ratio is the net credit sales for a given period divided by the average accounts receivable. The AR turnover ratio is used to determine a company’s efficacy at extending and collecting on credit with its clients. A high turnover ratio indicates that a business is more conservative in extending credit or more aggressive in collections.

This ratio can be used in conjunction with an allowance account or an allowance for doubtful accounts, which reflects the percentage of accounts receivable expected to be paid, to estimate future cash flow. An allowance account or an allowance for doubtful accounts is a contra asset; that is, it reduces the value of an asset in the general ledger to represent the cash the business expects to collect.

Where the AR/AP ratio demonstrates a company’s sales, the accounts receivable turnover ratio represents the efficiency of collections. With a healthy AR/AP ratio, your business is earning enough to cover expenses—even when clients default or pay late. A higher AR turnover ratio indicates that your business is doing a good job of collecting on invoices.

In essence, accounts receivable are a record of money your customers owe your business for the work or products you have already delivered. Poor record keeping in accounts receivable could lead to problems in audits and bad business decisions due to misunderstandings about cash flow. However, with good invoicing and accounting practices, you will have a clear understanding of your company’s financial health to guide your business strategy, secure financing, or inform potential investors.

Accounts Receivable Turnover Ratio: Definition, Formula & Examples

The accounts receivable turnover ratio is one metric to watch closely as it measures how effectively a company is handling collections. If money is not coming in from…

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What Is Accounts Receivable?

Accounts receivable aging report

Unfortunately, not all of your customers will pay their debts promptly, meaning you’ll likely have to do some chasing to recover those outstanding funds. This process, known as “dunning,” typically involves sending reminders to these (or soon-to-be delinquent) accounts. To track how well your dunning efforts are going, you should regularly create accounts receivable aging reports.

An A/R aging report (sometimes called an “A/R aging schedule”) records all of the outstanding payments that are still due to your business from your customers. It parses that data by how long the given debts have been owed. At a glance, you can track not only the individual promptness of each of your customers but also gain a thorough understanding of how smoothly your A/R operations are going.

A/R aging report example:

The example above uses 30-day increments to separate the debts, but if you follow an atypical billing cycle or offer non-standard credit options, you may choose an alternate schedule. Further, we provided a simpler format that identifies a company’s accounts receivable on a single row. However, suppose your business sends higher volumes of individual invoices to customers over a month. In that case, you’ll likely choose a more detailed format with additional rows that break out the owed amounts by specific invoice.

Accounts receivable formulas that help measure A/R health

Average accounts receivable.

As the name would suggest, average accounts receivable reflects the average value of debts owed to your business by its customers over a given period. In contrast, the A/R figures that you’ll see on a given financial report will exclusively reflect the specific value at the moment the reporting period is ended—offering little insight into the preceding days or weeks.

Admittedly, you likely won’t spend much time evaluating your average accounts receivable independently, but this value is critical for more complex performance metrics like net credit sales and accounts receivable turnover.

Average Accounts Receivable = (Beginning A/R Total + Ending A/R Total) ÷ 2

Accounts receivable turnover ratio

Sometimes referred to as the “debtor’s turnover ratio,” the average accounts receivable turnover (ART) ratio essentially tracks how many times a given company collects a sum of funds equal to its average accounts receivable balance throughout a set period (commonly a year). By monitoring this payout frequency, you can better manage how efficiently your business is collecting revenue—the higher the value, the more productive your A/R processes likely are.

Accounts Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable

Other important metrics

As you might imagine, there are other critical key performance indicators (KPIs) that you should be monitoring beyond the two primary ones we just outlined. Ideally, you’d also want to track:

• Average collection period
• Average delinquent days (ADD)
• Bad debt to sales
• Collection cost
• Collection Effectiveness Index (CEI)
• Day sales outstanding (DSO)
• Number of revised invoices
• Right party contacted (RPC) rate

What it means to manage your accounts receivable 

If your A/R performance metrics are lower than you want, the right strategies and policies can help you boost internal efficiencies while capturing more payments. Consider employing:

• Automation: Unneeded delays can drag out the entire A/R cycle. But with automated workflows that provide validation, authorization, and invoice creation without human effort, you can cut wait times out of your process.
• Due diligence: Financial tides can shift surprisingly fast, so you’ll want to actively monitor the ongoing financial health and credit history of your customers. And if you spot issues, consider limiting available credit or requiring advanced payment.
• Dunning: Don’t leave money on the table. Employ consistent, scheduled, multi-channel touches that gently but encourage payment.
• Early-payment incentives: Don’t forget the carrot when pursuing prompt payments. By offering a percentage discount or other perk for rapid invoice resolution, you can likely capture more interest.
• Formalized credit processes: Establish clear guidelines that dictate how your business determines credit limits, payment terms, and penalties. Then, enforce these policies for all customers.
• Reporting and analytics: To address an issue effectively, it helps to know what is happening. With routine, comprehensive reports that capture a broad range of performance metrics, you can gain the insight to make smarter, better-informed process decisions.

Benefits of well-managed A/R  

Build customer loyalty.

There are few things more frustrating than struggling to give someone money. On paper, this should be a relatively easy task, but overly complicated or error-prone A/R processes can drag out the entire timeline. Conversely, an efficient, honest, and reliable payment process can improve customer satisfaction and even higher sales.

Cut administrative costs

You’ve got to spend money to collect money. Any measure that your business takes to monitor or capture the revenue from credit-based purchases will require technology and personnel—resources that you have to pay for. But when you can do more with less, you can better recoup some of that outstanding debt with a lower overhead of time, energy, and capital.

Expand your customer pool

Not every business has the cash to pay for purchases when they’re received. Resellers and manufacturers, for example, often need to make credit-based purchases to obtain the raw materials required to generate later profits. But when your A/R processes are lagging—particularly those efforts tied to credit monitoring and evaluation—knowing which potential buyers you can trust to pay may prove challenging and will limit potential sales. Conversely, with the right policies in place, you can recognize safer bets that you might have previously overlooked.

Strengthen your cash position

The most prominent benefit is the ability to secure payments for more of your outstanding debt, which directly relates to a corresponding increase in your cash position and overall revenue. Put simply, it means your business works for free less often.

How accounts receivable automation software can help improve your A/R workflow

Collections: By automating your dunning tasks , you can avoid unnecessary communication delays and ensure that your customers are being contacted consistently and at the right time.

Employee performance: Offload those mind-numbing, repetitive tasks to an automation platform that can never get bored. And without all of this busy work, your workers can instead focus on more strategic—and valuable—efforts, like building stronger customer relationships.

Fraud : The more people involved in your billing and financial efforts, the more risk you add to the entire process. Conversely, automation requires fewer touches to support your billing efforts, limiting the opportunity for underpayments, unauthorized discounts, and customer data theft.

Errors: Despite our best intentions, humans make mistakes. Automation limits the direct involvement of your personnel within your actual A/R activities, eroding the potential for calculation or transcription errors to show up in your billing, meaning your staff will spend a lot less time on dispute management.

Risk management: With automated A/R processes, you’ll receive a steady stream of data and metadata regarding customer habits and payment choices that can be easily collected and reported. Armed with these records, you can begin making data-driven decisions on how and to whom you extend credit.

Automated accounts receivable at Invoiced

With Invoiced’s Accounts Receivable Automation software, you can keep your payment processes moving without breaking the budget

Schedule a demo to observe how our Smart Chasing technology can make your dunning efforts consistent and seamless, spanning email, text, phone, and more. Or explore the software’s integrated self-service customer portal that can standardize and simplify the payment process for both parties. Our invoicing engine can handle the most complex workflows, performing validations, discount management, and dispute resolution without drawing in your staff.

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• Receivables
• Notes Receivable
• Credit Terms
• Cash Discount on Sales
• Accounting for Bad Debts
• Bad Debts Direct Write-off Method
• Bad Debts Allowance Method
• Bad Debts as % of Sales
• Bad Debts as % of Receivables
• Recovery of Bad Debts
• Accounts Receivable Aging
• Assignment of Accounts Receivable
• Factoring of Accounts Receivable

Accounting for Receivables

Receivables are amounts that a company is entitled to receive in cash/bank, with a receipt being due either at present or in future. Receivables may arise as a consequence of the company’s main operations i.e. the usual business or they may sometimes originate from other transactions.

Receivables are broadly classified into trade-receivables and non-trade receivables. Trade receivables are those receivables which originate from sales of goods and services by a business in the ordinary course of business. Non-trade receivables are the amounts due from third parties for transactions outside the primary course of business. Another way receivables may be classified is whether interest is chargeable on the amount outstanding.

Receivables are normally current assets, but some may have a non-current portion depending on their maturity.

Trade receivables include:

Accounts receivable

Notes receivable.

Accounts receivable are current assets which represent amounts to be collected from customers for goods sold or services provided. When a company sells goods or provides services, the customers usually do not make a payment on the spot. Instead, they are required to make payment within a certain time period, called credit period. The terms that determine the due date and the discount available if payment is made by a certain date are called credit terms .

When sales are made on credit, accounts receivable are created, which are recorded through the following journal entry:

The accounts receivable balance is presented on the balance sheet, net of any allowance for doubtful accounts as follows.

When cash is collected from the customer, the accounts receivable balance on the balance sheet is reduced through the following journal entry:

Many companies allow customers a certain percentage as cash discount when they make the payment quickly. The cash discount depends on the credit terms of the sale.

Note receivable are receivables supported by a written statement by the debtor to pay a specified sum on a specified date. Like accounts receivable, notes receivable arise in the ordinary course of business; but unlike accounts receivable they are in written form. Notes receivable usually require the debtor to pay interest. They may be current and non-current.

When a company receives a note receivable it records it using the following journal entry:

Interest on notes receivable is accrued as follows:

Non-trade receivables

None-trade receivables are receivables that arise from transactions other than those related to the company’s main course of business. Examples include:

• Advances to employees
• Advance tax paid
• Deposits placed with other companies (if advancing money is not the primary business)

Scarlet Systems, Inc. (SS) developed an ERP software for Johnson Tools, LLC (JT) for $200,000 due within 30 days of successful testing of the system. Testing was completed on 30 April and the software became operational. JT paid an amount of $100,000 on 15 May.

JT had to settle another large liability in April which resulted in it not being able to pay the remaining invoice amount (i.e. $100,000) by 30 May. On 1 June, JT CFO convinced SS finance team to accept a note receivable due within 60 days carrying interest rate of 5% per annum for the remaining outstanding balance. JT paid the interest and principal of the note receivable at its maturity.

Required: Journalize the above transactions.

The sale of software and related services is recorded through the following journal entry:

Payment by JT on 15 May is journalized as follows:

Conversion of accounts receivable to a note receivable on 1 May is booked via the following journal entry:

The following journal entry is made to account for the receipt of note receivable principal and interest:

Whereas, the interest income is calculated as: $100,000 × 5% × 60/360

by Irfanullah Jan, ACCA and last modified on Oct 24, 2020

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Factor Accounts Receivable

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on January 30, 2024

Fact Checked

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Table of Contents

Definition and explanation.

The original holder obtains cash at once in return for the proceeds collected in the future, except that the collection process is handled by a third party (often known as a fa ctor ).

If the assigned receivables are insufficient to repay the factor because of bad debts , the original holder must transfer additional receivables.

If the factor collects more than the amount advanced, the excess is turned back to the original holder, as well as any uncollected accounts .

Suppose that Sample Company obtains $80,000 cash on 31 December 2023 by assigning $100,000 of its receivables with recourse.

The factor will collect the receivables and keep the first $85,000 to repay the cash advance and a $5,000 service charge.

Settlement is to be made on 1 April 2024, which will involve making a payment to Sample Company of any excess cash and the return of the uncollected accounts. The journal entries shown below would be made.

The journal entry used to record the cash received from the factor is as follows:

The journal entry used to record the transfer of the receivables to the factor:

The journal entries to accrue the finance charge are shown below.

This last entry reflects the fact that the factor collected $92,000 cash and kept $85,000. The uncollected accounts are transferred back.

This example illustrates how the events described in the previous section would be reflected in Sample Company's balance sheet —assuming, for simplicity, that nothing else happens.

Notice that the payable to the factor is contra to the assigned receivables. Until informed about the amount collected and kept, the company will continue to carry the assigned receivables and the payable on the books at their original amounts.

The net result of the arrangement is that Sample Company exchanged $85,000 of its receivables for $80,000 cash.

Assignment Without Recourse

Assigning without recourse differs from as signing with recourse in that the factor does not get to substitute other accounts for the uncollectible ones.

The factor does not have to return any cash in excess of the amount advanced or any uncollected accounts.

In effect, assignment without recourse is the same as an outright sale of the receivables.

Accounting for this transaction is si mple because it is the same as the sale of any other asset . The holder records a loss for the difference between the proceeds and the book value .

The factor (or buyer) usually obtains a high discount from the book value of the receivables because of the risk of uncollectibility.

Suppose that Sample Company receives $90,000 cash on 31 December 2023 for assigning $100,000 of its receivables without recourse. The following journal entry would be recorded:

This arrangement is essentially the one used by retailers when they enroll in a bank credit card plan.

Upon submitting charge slips from customers, they receive a credit in their bank account for a percentage of the sale.

The cost is incurred by the retailer for the following purposes:

• Obtain the cash quickly
• Avoid bad debt losses
• Save clerical costs
• Increase sales

Since the arrangement dealing with credit cards is related to ongoing operations, the debit entry is made to an expense account instead of a loss account.

Factor Accounts Receivable FAQs

What is factoring.

Factoring is a form of financing in which your company sells its Accounts Receivable (collectible debt owed to you by customers) to another business known as the "factor" at a discount.

Does my company need any special expertise or training to do factoring?

No, regular businesses can successfully factor their Accounts Receivable. A factor will help your company complete all of the paperwork and advise you on how to optimize its factoring program.

How much money should I factor in?

A business should factor all of the Accounts Receivable that are within 90 days old. This will give you more control over your Cash Flow since you can factor on a regular basis instead of waiting until you have collected enough money to pay off an entire account payable.

Will factoring affect our company's credit rating?

No, it will not affect your company's credit rating. There is no impact on a company's current line of credit and it does not affect the company's ability to obtain additional borrowing in the future.

What are "factoring fees" and do I have to pay them?

The factor will charge a separate fee for its services when it purchases your Accounts Receivable. This fee is usually not more than 1% of the total sales price and it may be negotiable.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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• Security Interests

United Nations Convention on the Assignment of Receivables in International Trade (New York, 2001)

Date of adoption: 12 December 2001

The purpose of the Convention is to promote the movement of goods and services across national borders by facilitating increased access to lower-cost credit.

Why is it relevant?

The transactions covered by the Convention (e.g. asset-based lending, factoring, forfaiting, securitization, project financing) are fundamental for the financing of international trade. Yet uncertainty as to the content and choice of legal regime applicable to the assignment of receivables constitutes an obstacle to international trade. As a result, an assignment of future receivables or a bulk assignment of receivables that are not identified individually may be ineffective. In addition, an assignment that is effective according to the law under which it was concluded, may not be enforceable as against the debtor in another country or be subordinated to the rights of competing claimants in another country. Moreover, the law applicable to conflicts of priority among competing claimants may be difficult to determine. This means that either credit is not available on the basis of receivables (e.g. the claim for the payment of the purchase price in a contract for the sale of goods) or credit is available but only to those that may be able to afford its cost; and lack of sufficient access to credit or high cost of credit is a disadvantage in particular for small- and medium-size enterprises.

Key provisions

The Convention removes legal obstacles to receivables financing transactions, inter alia, by: (a) validating assignments of future receivables and bulk assignments, and by partially invalidating contractual limitations to the assignment of receivables); (b) enhancing certainty with respect to a number of issues, such as the effectiveness of an assignment as between the assignor and the assignee and as against the debtor; (c) clarifying the law applicable to key issues, such as the priority between competing claims; and (d) providing a substantive law regime governing priority between competing claims that States may adopt on an optional basis.

Relation to private international law and existing domestic law

The Convention applies only to international assignments of receivables and to the assignment of international receivables (with the exception of "financial" receivables). However, the Convention may affect a domestic assignment of a domestic receivable if: (a) it is in conflict with an international assignment of the same receivable; or (b) if it is one in a series of subsequent assignments, one of which, falls within the scope of the Convention. For the debtor, related provisions of the Convention to apply, at the time of the conclusion of the contract from which the assigned receivables arise, the debtor has to be located in a Contracting State or the law governing the assigned receivables has to be the law of a Contracting State.

Additional information

The Convention contains an optional part with applicable law rules and another optional part with substantive rules dealing with the third-party effectiveness and priority of an assignment of receivables.

The Convention is accompanied by an explanatory note. There is also an-article-by-article commentary on the draft Convention that was before the Commission at its 34 th session in 2001.

Additional Resources

• Text - Explanatory note
• UNCITRAL Legislative Guide on Secured Transactions: Supplement on Security Rights in Intellectual Property (2010)
• UNCITRAL Legislative Guide on Secured Transactions (2007)
• United Nations Convention on Contracts for the International Sale of Goods (Vienna, 1980)
• General Assembly resolution 56/81

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Risk & Compliance

How New York UCC, Article 9, applies to the sale and purchase of accounts receivable

August 2019   |  EXPERT BRIEFING  |  BANKING & FINANCE

financierworldwide.com

The sale of accounts receivable is a viable option for sellers to increase cash flow. Likewise, purchasing accounts receivable at a discount can be a good business opportunity. When buying accounts receivable, purchasers must comply with Article 9 of the New York Uniform Commercial Code (UCC) in order to record the change in ownership.

This article explores the methods by which a party can sell (assignor) its accounts receivable (debt) to a purchaser (assignee) and mitigate future risks associated with non-payment by the party obligated to pay into the account (debtor).

Introduction: application of the UCC to assignments

Determining who owns an account receivable can be difficult because accounts are intangible in nature. Article 9 of the UCC protects purchasers of accounts receivable by providing a method to record ownership. Recording the sale of the receivable is accomplished by filing a UCC financing statement. The filing serves multiple purposes. It can be used to show ownership and require payment from the debtor, provides notice of sale to other creditors and can be used to defeat or rank competing claims to the same account in bankruptcy.

Article 9 states that a purchaser or assignee receives a “security interest” through assignment. This may raise concerns for a buyer that wants to obtain full rights in the accounts receivable and not just a security interest, which is commonly given to secure a loan but does not include enforcement rights until a default. In addition, the sale of an account is recorded in the same manner as a security interest serving as collateral, namely, by filing a UCC-1 financing statement. However, according to the official comments to the UCC, despite the somewhat confusing language, the assignee in fact obtains full ownership over the account receivable it purchases. Use of terminology such as “security interest” is merely a drafting convention, and “has no relevance in distinguishing sales from other transactions”.

Assignability of a debt (i.e., accounts receivable)

General conditions of the UCC Article 9. There are three general conditions, outlined below, that must be satisfied to effect the sale of an account receivable under Article 9.

First, assignment must fall within the scope of “account”: An “[a]ccount… means a right to payment of a monetary obligation whether or not earned by performance: … for services rendered or to be rendered”. A debt which relates to the provision of goods, and not just services, also satisfies the conditions necessary to effect assignment of a debt. While the definition of “account” under the UCC does not explicitly include goods, the official comment provides that the definition of “account” is not limited to just “goods or services”, rather, the definition has “expanded”.

Second, when purchasing accounts receivable or debts for goods sold, the filing of a UCC financing statement (UCC-1) by the purchaser is mandatory.

Third, notice to the debtor may be given. If the assignee decides that it wants the debtor to pay it directly, then notice to the debtor is required under the UCC. Without notice, the debtor “may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notification”. Notice is often not provided until there is a default by the assignor because companies often sell their accounts receivable and continue to collect the amounts due from customers on behalf of the assignee. This is often done because the assignor does not want its customers to know it is using accounts receivable to finance its business. Furthermore, the assignor may have a better ability to collect due to close business ties.

Effect of contractual anti-assignment provisions. A party to a contract may want to prohibit assignment for a variety of reasons. However, New York generally favours assignments. In fact, under New York law, while violation of contractual language prohibiting assignment or requiring the approval of one party may trigger a breach of contract by the assignor, this does not invalidate the transfer. In order to make an assignment ineffective, contractual language must be very explicit, such as a provision stating that any attempted assignment is “void”.

The UCC provides additional protection to accounts receivable, in that anti-assignment provisions are ineffective if they attempt to restrict the sale or grant of a security interest in an account. Thus, accounts receivable may be sold despite contractual restrictions prohibiting such transfers.

Validity of an assignment

Legal requirements for valid assignment. In general, “a security agreement is effective according to its terms between the parties, against purchasers of the collateral, and against creditors”. A security interest (i.e., assignment) is enforceable if value was given, the assignor had the authority to transfer its rights in the collateral to the secured party and the assignor authenticated a security agreement that provides a description of the collateral (defining “authenticate” as “to sign, or with present intent to adopt or accept a record, to attach to or logically associate with the record an electronic sound, symbol, or process” such as an electronic signature).

The term security agreement is defined in the UCC as “an agreement that creates or provides for a security interest”. As discussed, the term “security interest” is a UCC drafting convention and is not distinguished from a sale.

Validity of assignment of part of a debt. Partial assignments are valid and enforceable. H Co., Ltd. v. Michael Kors Stores, LLC (2009) found that “an assignment may be for ‘a part only of the designated payment’”. In addition, Terino v. LeClair (1966) found that “debt which was partially assigned was to be created and payment was to become due in the future did not render equitable assignment invalid”.

Rights and title that passes from the assignor to the assignee. When assignment is performed correctly, the assignee receives all rights, title and interest possessed by the assignor with respect to the debt (i.e., accounts receivable). The assignor will have no remaining power over, or interest in, the debt.

As per the UCC, the assignee receives unencumbered rights as existing under the original contract and those arising from the original transaction. The rights of an assignee are subject to: (i) all terms of the agreement between the account debtor and assignor and any defence or claim in recoupment arising from the transaction that gave rise to the contract; and (ii) any other defence or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.

In addition, the purchaser of the debt takes the debt subject to previously recorded sales or filed financing statements conveying or covering the same debt. For example, financing banks often take a security interest in all of a debtor’s property, including accounts. If the description in the prior-filed financing statement covers “accounts” of the assignor “generally”, the assignee will need to obtain an intercreditor agreement subordinating the financing bank’s interest in the account or the assignee’s interest will remain subject to the prior-filed security interest of the financing bank.

The assignee may assign the debt to another party. The new assignee will have the same rights, privileges, and interest in the debt. Further, “[i]f a secured party assigned a perfected security interest, a filing [of a UCC financing statement] is not required to continue the perfected status of the security interest against creditors of and transferees from the original debtor”. However, it is good practice to file an amendment identifying the new secured party or owner of the receivable.

Automatic assignment of future debts. The UCC provides that, subject to certain exceptions, a security agreement may create a security interest in after-acquired collateral, and may provide that accounts are sold in connection with future advances. Accordingly, so long as the description in the financing statement continues to accurately describe the collateral (i.e., the debt), no new filing is required. Therefore, the assignee may specify in its assignment agreement with the assignor that future debts are assigned to the assignee “as they arise” or similar language.

Perfection, priority and notice of assignment

What to file . New York requires the filing of form UCC-1, financing statement. A financing statement must have the assignor’s proper corporate name (not the trade name), the assignee’s name, and an indication of the collateral (i.e., the debt and the specific account receivable). The UCC indicates that financing statements should contain: the assignor’s address, whether the assignor is an individual or organisation, registration numbers and the assignee’s address. A financing statement is effective for five years and may be renewed for an additional five years.

Where to file . Under the UCC, the general rule is that the place for filing is a debtor’s location. However, in the context of assignment, location of the debtor does not affect the validity of the financing statement. Rather, it is the location of the assignor that is important. If the assignor is a corporation or similar corporate entity, filing must be done in the state of incorporation. If the assignor is an individual, then in the state of the assignor’s residence. If the assignor is an unincorporated business, then in the state of the assignor’s principal place of business or chief executive office. Generally, financing statements are filed with the Secretary of State’s office in the appropriate jurisdiction. In addition, any person can file a financing statement if the assignee authorises the filing in an authenticated (signed) record or agreement.

How long to file. Generally, there is no time period within which a security interest must be perfected by filing the financing statement. However, New York follows the “first in time, first in right” rule. Thus, the assignee’s security interest should be perfected as soon as possible to prevent another purchaser or creditor from priming the assignee’s security interest.

Preservation of assignment rights in bankruptcy

Importance of perfection for bankruptcy. In the event of bankruptcy by either the debtor or assignor, whether or not a debt has been perfected will play a critical role in determining the value of a claim against the debtor’s estate. The assignee, in effect, stands in the shoes of the assignor. Therefore, if neither the assignee nor the assignor have perfected their security interest against the debtor, then the assignee will be an unsecured creditor in the debtor’s bankruptcy.

In the event that the assignor declares bankruptcy and the assignee has not filed appropriate financing statements, the accounts sold to the assignee may become an asset of the debtor’s estate. In this scenario, the assignee is an unsecured creditor. If, however, the assignee has filed the appropriate financing statement conveying the accounts were sold to the assignee, the accounts are not considered property of the debtor or its bankruptcy estate.

The sale of receivables is a common way for businesses to finance ongoing operations including the purchase of inventory. If the proper formalities are followed, a purchaser can be reasonably assured that they have priority to, and ownership of, the account receivable.

John Kissane is a partner and Sabih Siddiqi and Celinda Metro are associates at Watson Farley & Williams LLP. Mr Kissane can be contacted on +1 (212) 922 2200 or by email: [email protected]. Mr Siddiqi can be contacted on +1 (212) 922 2200 or by email: [email protected]. Ms Metro can be contacted on +1 (212) 922 2200 or by email: [email protected].

© Financier Worldwide

John Kissane, Sabih Siddiqi and Celinda Metro

Watson Farley & Williams LLP