The financial flexibility or capability of an entity to raise money out of its receivables
During a general business decline, an entity may find itself in tight cash position because sales decrease and customers are not paying their accounts on time
The entity's current accounts and notes payable must continue to be paid if its credit standing is not to suffer
If the situation becomes very critical, the entity may be forced to look for cash by financing its receivables
Common forms of receivable financing
Pledge of accounts receivable
Assignment of accounts receivable
Factoring of accounts receivable
Discounting of notes receivable
Pledge of accounts receivable
When loans are obtained from the bank or any lending institution, the accounts receivable may be pledged as collateral security for the payment of the loan
Pledge of accounts receivable
Borrowing entity makes the collections of the pledged accounts but may be required to turn over the collections to the bank in satisfaction for the loan
Loan recording
Debit cash and discount on note payable if loan is discounted, and credit note payable
Loan repayment recording
Debit note payable and credit cash
With respect to the pledged accounts, no entry would be necessary. It is sufficient that disclosure thereof is made in a note to financial statement
Notes Receivable
A written promise to pay a specified amount of money on a specified future date
Accounts Receivable
Money owed to a company by its customers for goods or services provided on credit
Loss on note discounting
The difference between the face value of a note and the amount received when the note is discounted
Interest Income
Revenue earned from lending money or extending credit
Discounting a note receivable
1. Receiving cash for the note before its maturity date
2. Recognising a loss on the discounting
3. Recognising interest income on the discounted note