If you’re scrambling to pay your vendors or meet payroll expenses, is it a good idea to sell your receivables at a loss? This is becoming more popular in todays’ down economy but you must also account for those losses on the books.
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The Art of Selling Receivables
Bloomberg Businessweek reporter, Karen Klein offered up some insight into selling receivables and why business owners are finding this option attractive.
Ms. Klein offers the example of one Tiffany Bucher, owner of Infincom who was informed by her bank all of her accounts were frozen and the bank was calling in her line-of-credit (LOC) loan in the amount of $150,000, even though her monthly nut on the note was around $540; something she could afford.
In a panic, Ms. Bucher turned to FWS Funding, a source that says on its web page it provides financing for working capital, restructuring, refinancing, expansion growth, acquisitions and operating setbacks. It appears Bucher needed it for the latter—an operating setback as she had $80,000 in payroll expenses due the day after the bank notified her of the frozen accounts and lost LOC.
FWS funded her payroll within 24 hours and Bucher was happy as a camper; however, before you think this will work for your small business, according to the Bloomberg Businessweek report, Bucher’s company had approximately $8.5 million in revenues in 2010—probably not something most of us small biz owners see—but we can dream, right?
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Losses on Receivable Assets
In Ms. Bucher’s case what FWS Funding does (and most companies such as FWS do the same) is purchase her receivables at a discounted rate so she has available cash. Once Bucher receives the needed cash to meet her payroll, the receivables are no longer hers but that doesn’t mean FWS Funding won’t collect the entire nut due from each A/R customer and perhaps even insert some past due interest, penalties and late fees if indeed they will buy any A/R accounts over 60 days, which most companies such as these won’t.
Before I talk about why I think this is a bad idea and why it absolutely won’t work for most small business owners, you do need to account for those lost receivables on your books, and the IRS may not look at the entire amount as losses or expenses you can deduct at tax time.
Say you have a typical customer account that owes you $1,000, and after 120 days plus, you haven’t been able to collect a dime. At year end when your tax professional suggests you write this $1,000 off as a bad debt, that’s an expense, albeit an unwanted expense—any business would rather have the cash than an expensed-out asset.
In Bucher’s case (and I want to make it clear here I am not a CPA but have been a small business owner for over 17 years), it would appear she needed at least $80,000 to meet her payroll the following day, meaning she lost out on $20,000 of receivables. (Note: This is an example scenario and I’m not privy to the terms and conditions of Bucher’s agreement with FWS).
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Writing Off the Bad Debt
At first glance one might think, “Hey this lady can write off $20,000 in bad debt!" Hold on here, folks. One needs to factor in the initial sale (receivable or not) the cost of sale, the profit the company gained and then determine actual losses on sold receivables—so indeed the entire $20,000 may not be a total write off. Remember, when those receivables became receivables they were earned income, so you’ll need to check with your tax professional or CPA on how these losses will be handled.
If you think this is a good option for you and are able to find a company such as FWS to aid you in needed cash for buying your receivables at a discount, you need to account for the lost receivables on your books.
You will need to determine how much you have invested in attempting to collect on old receivables (salaries) and how much possible interest, late fees or penalties you lost or charged (non-recoverable). In our scenario, your total receivables including all the costs to collect them may be higher than the $100,000 of receivables you sold, and those amounts are additional losses. Further, if your receivables are in a scheduled, controlled account, those journal entries will be more complex.
Writing off bad debts is never fun and its frowned upon by bankers, investors and business partners as it makes you look incapable of handling the day-to-day operations of running a business in the first place.
First off, once they are sold and are now being collected upon by a company that’s not your company, especially the current receivables, what does that say to your loyal customers? To some it may come across as a message such as “Don’t they trust me to pay my bills? Excuse me, I’ll go somewhere else!" And, if the new collector is more aggressive in collection procedures than you are, this may also leave your customers asking questions or questioning your company tactics.
As far as your lenders or possible funding down the road goes, if you need to sell an asset at a loss to pay expenses, they won’t look upon this as your being able to effectively manage and operate your business, so think twice before choosing this option. That's because once you do it, the journal entries will be on your books and you’ll have to explain why you sold receivables for cash.
Finally, for the small business owner who has receivables in the $5,000 to $10,000 to even $20,000 range, companies who buy receivables may not be interested in them – they may look at them as being too low when compared to your annual revenues (remember Infincom had $8.5 million in revenues). Plus, if out of the salable receivables you have and most are 60 days or more past due, these companies won’t be interested in purchasing them in fear of not being able to realize revenue on your bad debts.
My advice? Before you do this (and most small business owners out there are on a smaller scale than Infincom), talk to your banker. Have a sit down and see if there is any way he or she can help whether it’s pledging some collateral for a short-term loan or asking for some help for a few days until you can get back on your feet. Remember, your banker should be your best friend, so treat him like one; and when rainy days like these come around, they’ll be more willing to help.
If your banker does step up to the plate to help, and, say, covers your nut for three days, you'd better make sure you will have that money before you even accept the offer—better yet, make sure you will have the money before you even approach your banker. If you don’t, you won’t get the same friendly help the next time you ask.
So, have you sold your receivables or are you considering this option? If so, I’d like to hear what made you decide this was your only option or how it worked out for your company. Your comments will help other small biz owners seeking to do the same, so drop me a comment below. Your fellow small business owners await your experience and advice!