Assignment of receivables: how to generate cash flow with unpaid invoices

Assigning your accounts receivable to a third party is part of a group of short-term financing options for small businesses. If your customer payment terms are relatively long, you’re often caught short on the cash you need to pay suppliers and staff, or invest in exciting opportunities that arise. 

So the ability to turn unpaid invoices into liquid funds can be very appealing. 

But the process isn’t exactly simple, and many SMBs don’t know what’s involved. So here’s a brief guide to everything you need to know about the assignment of receivables.

Assignment of accounts receivable: definition

The assignment of accounts receivable is a fiscal mechanism by which a creditor (the “assignor”) transfers the rights over an invoice to a third party (the “assignee”) in exchange for a short term loan. 

Here’s an example: suppose a customer owes you a sum of money, due in two months’ time. You can assign that debt to another company as collateral for money up front (a loan). If you fail to repay the loan in time, the other company will then collect payment from the customer in due course. 

The costs can vary, but you can expect to pay interest and some form of processing fees along the way. Obviously, the sooner you repay, the less you’ll pay in the long run. 

Why opt for assignment of receivables? 

This is a strategic tool to optimise working capital and keep your business humming along.  Tangibly, the assignment of receivables puts more cash in your accounts today. This helps you keep up with payments and maintain better relations with your suppliers.

Companies can use assignment of receivables to meet their cash flow needs. It can therefore be useful in a number of contexts:

• Cash flow management: Assignment of receivables allows you to convert your invoices into immediate cash. You improve your cash flow and meet your short-term financing needs.
• Reducing credit risk: Any credit risk transfers to the assignee. This protects you against the risks associated with unreliable buyers or uncertain economic situations. Of course, the assignee is unlikely to assume too much risk, so this isn’t a sustainable or scalable way to bring down major credit risks.
• Financing and refinancing: Assignment of receivables can be used as a means of financing, enabling you to obtain funds to invest in new projects, cover expenses or repay existing debts.
• Outsourcing receivables management: Invoice administration can be complex and time-consuming. By assigning your receivables, you can outsource the management of collections and payments to the assignee, allowing you to concentrate on your core business.
• Mergers and acquisitions: As part of a company takeover, the assignment of receivables can facilitate the consolidation of financial operations and simplify the transition of commercial relations between the parties involved.

There are potential downsides, even if they’re relatively few: 

• Paying fees and/or interest means that you take home a smaller portion of what the customer owes you. But having the money in your pocket is often more important. 
• You’re involving a third party in your customer relationships, which could potentially become awkward. 
• It can be administratively complex and a slower process than you’d like. We’ll explore some ways to make it more efficient shortly. 

Despite these drawbacks, assigning receivables is often a very attractive option where you’ve done the hard work to sign customers and have real assets (invoices), but don’t have the cash you need.  

Technical requirements for assignments

To be valid, the assignment must be in a written document including certain information: 

• Identification of the parties 
• Nature of the claim
• Amount assigned
• Payment terms and conditions
• Notification to the debtor so that the assignment can be enforced (if necessary)

To get a little more legal, the assigned claim must also meet the following criteria:

• The claim must be certain, liquid and due:some text
  • Certain: The claim must not be disputed
  • Liquid: It must be quantified or quantifiable
  • Due and payable: It must be due and payable on demand
• The debtor must be informed of the assignment by the assignor or the assignee, by registered letter with acknowledgement of receipt, bailiff's deed, or any other means proving receipt.
• Constraints and limitations must be clearly defined in advance. These include:some text
  • Clauses prohibiting further assignments
  • Automatic termination clauses
  • Forfeiture in the event of assignment

The specific rules may vary from one country to another. Certain claims may be excluded from assignment, in particular those that are linked to the private people or to a particular relationship between the parties, such as alimony, civil or military pensions and wages. 

Legal or contractual restrictions may also limit the possibility of assigning a claim.

Who’s involved in the assignment of receivables?

The main players in the assignment of receivables are:

• The assignor: The company transferring the receivable, whether it is a commercial, industrial or service company.
• The assignee: The party acquiring the receivable, such as a bank or a factoring company. The assignee collects the sums due and assumes the risks of the debtor's insolvency if the assignor can’t repay their loan.
• The assigned debtor: The customer of the assigning company, who must pay its debt to the assignee.

What does an assignment of receivables entail?

The exact implications of an assignment of receivables will vary depending on the jurisdiction, applicable laws, and the agreement you reach. You are strongly advised to seek the advice of a legal professional for advice tailored to your particular situation. An expert will be able to guide you through the laws and regulations in force in your country and help you understand the specific implications of the assignment of receivables.

However, here is a list of common implications:

• Transfer of rights and obligations: The rights attached to the claim are transferred to the assignee, including the right to sue the debtor in the event of non-payment. The assignee may also acquire the obligations associated with the claim, such as the obligation to comply with the agreed repayment terms.
• Notification to the debtor: The assignor is generally required to notify the debtor (the customer) of the assignment of claims, informing them of the change of creditor and obliging them to make payments to the assignee rather than the assignor. The customer may be required to consent to the assignment of claims, depending on the applicable legislation.
• Payment to the assignee: The debtor must make payments to the acquiring company in accordance with the agreed terms. The latter has the right to claim and receive payments relating to the assigned receivable.
• Risks and guarantees: The assignee must assess the risks associated with the receivable before accepting the assignment, including the debtor's solvency and the existence of guarantees or sureties associated with the receivable.

Assignment of receivables vs factoring

While similar, the assignment of receivables is slightly different from factoring. Invoice factoring also involves assigning receivables to a third party, but in that case you essentially sell these assets rather than use them as collateral. A factor will buy a portfolio of invoices from you and take over the collection process from there. 

In both cases you get money now for customer debts that will come due later. The key differences are in the terms and the amount of credit you hand over. 

Conclusion

The assignment of receivables is a strategic tool for optimizing financial management and securing your commercial transactions. It allows the creditor to offload the collection of a debt or to mobilize funds, while offering the assignee the opportunity to acquire receivables at a lower cost and to diversify its portfolio. 

Ultimately, this helps you to keep up your payments and maintain better relations with your suppliers. 

Defacto, a less burdensome, simpler and more flexible alternative

Defacto offers an interesting alternative to the often complicated, legally-intense process described above. We offer short-term loans, using outstanding invoices as proof of your ability to honor them. 

Defacto financing is fast, flexible, and far more affordable than traditional invoice factoring or receivables-based loans. You choose which receivables you want to use to raise funds, and avoid the restrictive rules often imposed by other mechanisms.

In as little as 27 seconds, you can get the funds you need to help you business grow and thrive. See how easy it is here.