Working Capital Financing^369
Pledging Accounts Receivable
After cash and marketable securities, accounts receivable are considered to be the
most liquid assets on a firmís balance sheet. A financial institution such as a bank or
finance company will readily make a loan secured by accounts receivable. The lender
will evaluate the quality of the receivable to be pledge and the average size of account
pledged. Once these have been established, the pledging procedure can be implemented.
These steps are explained in the following paragraphs.
Quality of Receivables Pledged. The lending institution is gone to evaluate thoroughly
the quality of the receivables the borrower wants to pledge. If, on the average, the
receivables appear to be of very high quality with almost a 100 per cent probability of
payment, the lender may loan up to 90 per cent of the face amount of the receivables
pledged. If the receivables appear to be of relatively low quality, the lender may be
willing to lend only 25 per cent of the face value of the receivables. The higher the
receivable quality, the higher their loan value.
Although a lender may be willing to lend anywhere from 25 to 90 per cent of the face
value of the receivables pledged, he retains the right to reject any receivable that he
does not wish to accept as a pledge. In addition, the lender holds the borrower liable for
any accounts that become delinquent or default after they have been pledged.
Size of Accounts. Pledging receivables involves a considerable amount of record keeping
for the lender. These record-keeping costs remain relatively constant irrespective of
the rupee amount of the account being pledged. Smaller-size accounts cost more per
rupee of loan than larger-size accounts. A firm with a lot of small-size accounts receivable
will find it difficult to raise funds by pledging receivable at a reasonable cost. A firm
may be able to negotiate a ìfloating lienî loan with a lending institution. With a floating
lien the lender does not maintain records on individual accounts. Rather, a general lien
is assigned to all receivables. Since the lender is not tracking individual accounts under
a floating lien the chances of fraud by the borrower are higher than with specific
pledging of accounts. As a precaution against exposing itself to undue risk, a lender will
rarely lend more than 25 per cent of the face amount of receivables subject to a floating
lien.
Pledging Procedure. Once the loan value of receivables has been established, the
borrower sends to the lender a list of accounts, billing dates, and amounts involved.
Assume that the lender has agreed to lend 80 per cent of the face value of receivables
pledged. The borrower sends to the lender a schedule of accounts totalling Rs 1 crore.
The borrower is now eligible to borrow any amount up to 80 per cent of Rs 1 crore, or
Rs 80,00,000, upon signing a promissory note.