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Journal Entries For Factoring Receivables

See Also:
Factoring
Another Way To Look At Factoring
Accounting for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
Factoring is Not for My Company
History of Factoring
How Factoring Can Make or Save Money
The What, When, and Where about Factoring
Journal Entries (JEs)

Journal Entries for Factoring Receivables

The following scenario will provide a clear, simple and effective way to record journal entries for factored receivables. In the spirit of simplicity and efficiency, remember that your journal entries ought to be booked only once per day on a daily summary basis (i.e. ‘ONE BIG JE ONCE PER DAY‘). You should then use the lender’s reports as the source document for these journal entries. But make sure you double-check your journal entries by auditing the report(s) sent by the factoring lender.

Case 1- Selling Receivables

Assumptions:

  1. Factored Receivable: $ 100,000
  2. Advance Rate: 80%
  3. Factored Fee Expense (FFE): $ 1,000

There are three accounts which need to be created to account for a factoring relationship based on With Recourse Conditions, including the following:

Step 1- Initial Funding by Lender

To account for the initial funding (when the lender selects the invoices from the Schedule A form to advance funds), make the following entry:

Assuming a $100,000 receivable with an 80% advance rate:

Dr. Cash 80,000
Cr. FIS 80,000

(If you want to manage and improve your company’s cash flow in 24 hours, download the 25 Ways to Improve Cash Flow whitepaper.)

Step 2- Receipt of Customer Payment

Accounting for customer payments will require the use of the Collections Report, which is produced daily by the lender. As you identify each invoice and the net reserve (i.e. the extra $ 20,000) is remitted by the lender, apply the payment to the invoice in the accounts receivable journal by debiting the FIS account.

Assuming a $100,000 payment in full by customer:

Dr. Cash 19,000
Dr. FFE 1,000
Dr. FIS 80,000
Cr. A/R 100,000

In booking the journal entries in this manner, your cash balance will increase by $99,000 at the end of the transaction cycle. And the other $ 1,000 will show up as a fee expense on the P&L statement. Upon full payment, “zero out” both the A/R (asset account) and the FIS (contra asset account).

Step 3- Partial Payment of Invoice(s) by Customer

If a customer short pays, then only apply the amount paid to the invoice in the journal in the manner above. For payments on non-factored invoices, apply against the FIR account.

Case 2- Handling Invoice Buybacks (When the Customer Doesn’t Pay You)

To handle the buyback of an invoice, make the following entry:

Dr. FIS 80,000
Dr. FFE 1,000
Cr. FIR 81,000

By tracking your cash flow, this just one of the many ways as a financial leader you can add value. For more ways to improve your cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

Journal entries for factoring receivables

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Every Business Has A Funding Source, Few Have A Lender

See Also:
Bankers’ Language is Financial Jargon
Categories of Banks
Finding the Right Lender
How to Manage Your Banking Relationship
Interest Rate
Is it Time to Find a New Bank?

Every Business Has A Funding Source, Few Have A Lender

While visiting with a potential customer, he asked, “Why are lenders such an obstacle standing between an entrepreneur and a funding source’s money?

I really don’t like to answer a question with a question but in this case I did, “Do you do business with an institution or a lender?” I went ahead and answered by saying you don’t do business with an institution. You do business with people. When you get a lender who believes in you, you can accomplish things that are hard to believe. I continued by saying a good lender relationship can bring you money in the form of credit, save you money in fees, and enhance your business opportunities through taking advantage of the lender’s extensive contacts.

Lending Relationships

Relationships between lenders and entrepreneurs/business owners take on as many colors and shapes as relationships between you and your life partner. But, as you know, the most important part of any relationship is to have trust and honest communication.

A Good Lender Relationship

The problem here is a good lender relationship can be so beneficial. But, most entrepreneurs/business owners suffer through poor ones, or cultivate none at all. In my discussions with lenders, they feel that the entrepreneurs don’t understand their restraints and needs. Lenders are not investors risking their personal money investing in your business. In addition, lenders are loaning you money that individuals or companies have deposited with the institution. That money is then paid back to the depositors. Lenders by law and temperament are not investors.

As in any relationship you need to understand the other party’s side, which in this case, is the lender. Lenders do not have the same lucrative potential as an investor. As an entrepreneur, you are normally asking a lender to take an investor risk instead of a lending risk. This is the main reason why bankers and entrepreneurs so often don’t see eye to eye.

The important part of dealing with a lender is the more they know about you and believe in you, the more capital (cash) you can obtain from them.

every business has a funding source, few have a lender

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Due Diligence on Lenders

See Also:
Relationship with Your Lender
Finding the Right Lender
The Dilemma of Financing a Start-up Company
Every Business has a Funding Source, Few have a Lender
Angel Investor

Due Diligence on Lenders

I am sure all of you have applied for some type of a loan from some institution to be used for college, car, home or business. By the end of the process, you have given them applications and supporting documents that, in some cases, can weigh several pounds. When I am involved in a transaction with a client, I encourage them to do as much due diligence on my company, Summit Financial Resources, as we will do on them.

Example of Due Diligence on Lenders

For example, I was recently told by a business woman named Robin that all lenders are the same. A little concerned with her comment, I asked “Why do you feel that way?” She went on to tell me that banks are controlled by the government; therefore, all banks have the same rules, so all banks are the same. She continued by saying, “I just use the bank located nearest to my business.” I replied, “I agree that government does control banks. But, the government rules are guidelines, and the lenders create their lending policies and procedures from these rules. Therefore, each lenders’ policies and procedures are different, so you really should consider doing due diligence.”

The reason for the due diligence is to determine which lender understands your needs, and to make sure the lender’s policies and procedures will meet those needs. Also, I believe you should make certain the lender understands and values your business.

While looking at me as if she was not sure I was believable, she asked “What should I ask a lender? They have the money and I don’t want to make them mad by asking questions about them.” I replied by saying “Well, if that is the case, do you really want to get in a lending relationship with them?” Now appearing convinced, she wanted to know what she should be looking for in a lender and stated “All I know for sure is I need their money to have the cash to grow my business.”

Decide On The Lender

I told her, first of all, you need to decide what size of lender is appropriate and again, to make sure they meet your needs. In my opinion, location does not come into the mix. I categorize lenders into four groups, big market, middle market, small market and those in it for the money (I will share details of this conversation in next week).

Next, do you like the lender? Does he or she want to understand your needs and value your business? The lender is going to check out your credit and personal references, so ask the lender for some current or past customers. The lender’s customers can provide you with information on the lender’s strengths and weaknesses.

Another thing you want to talk about with the lender is their support staff. Make sure you are comfortable with the pre-funding and post funding support staff. By doing this you will know if the support will be via voice mail system, Internet, or a real person.

Robin did find the lender she liked with Summit. I visited with her later and she thanked me and shared the many successes her business has experienced. Then she told me she had shared her new found knowledge of due diligence with her business associates.

Don’t leave any value on the table! Download the Top 10 Destroyers of Value whitepaper.

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Cost of Capital Definition

See Also:
Arbitrage Pricing Theory
Capital Budgeting Methods
Discount Rates NPV
Required Rate of Return
APV Valuation

Cost of Capital Definition

The cost of capital definition is a company’s cost of funding. Depending on the company’s capital structure, the cost of capital will incorporate its cost of debt as well as its cost of equity. Cost of debt refers to the company’s cost of raising funds through debt financing; whereas, cost of equity refers to the company’s cost of raising funds through equity offerings.

The cost of capital of a business represents the market’s required rate of return on capital invested in that company. It equals the rate of return on a project or investment with similar risk. A company’s cost of capital is the rate of return the company would earn if it invested its capital in a company of equivalent risk.

For a corporate project, cost of capital equals the rate of return on an investment or project of similar risk. The project cost of capital is the required rate of return, or hurdle rate, for the project. The expected returns of the project or investment must exceed the project cost of capital for the project to be deemed a worthwhile investment opportunity.


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Determining the Cost of Capital

Evaluating a project or investment requires determining the cost of capital. The investment will be attractive as long as the expected returns on the project or investment exceed the cost of capital. The cost of capital can be the cost of debt, the cost of equity, or a combination of both.

Cost of Debt

A company’s cost of debt represents its borrowing costs on loans, bonds, and other debt instruments. It is the company’s debt financing costs. A higher cost of debt means the company has poor credit and higher risk. A lower cost of debt implies the company has good credit and less risk.

Calculating the cost of debt is relatively simple. It is the interest rate on the company’s debt obligations. If the company has numerous differing debt obligations, then the cost of debt is the weighted average of those interest rates.

Cost of Equity

Cost of equity refers to the market’s required return on an equity investment. It is the return required to get investors to purchase shares of a company’s equity. Furthermore, investors will demand a specific return for invested capital given the risk of the equity investment. The cost of equity, which compensates investors for time value and a risk premium, is that required rate.

You can either calculate the cost of equity by using the capital asset pricing model (CAPM) or the dividend capitalization model. It can also be estimated by finding the cost of equity of projects or investments with similar risk. Like with the cost of debt, if the company has more than one source of equity – such as common stock and preferred stock – then the cost of equity will be a weighted average of the different return rates.

Cost of Equity Formula

The following formula is the dividend capitalization model, or the cost of equity formula.

Ke = ( D1 / P0 ) + G

Ke – cost of equity
D1 – next year’s dividend
P0 – current stock price
G – dividend growth rate

Weighted Average Cost of Capital (WACC)

Combining the cost of equity and the cost of debt in a weighted average will give you the company’s weighted average cost of capital, or WACC. This rate can also be considered the required rate of return, or the hurdle rate of return, that a proposed project’s return must exceed in order for the company to consider it a viable investment.

If you want to find out more about how you can add more value to your organization, then click here to download the Know Your Economics Worksheet.

cost of capital definition

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Baby Bonds

See Also:
Coupon Rate Bond
Non-Investment Grade Bonds (Unsecured Debentures)
Par Value of a Bond
What is a Bond?
Yield to Maturity of a Bond

Baby Bonds Definition

The baby bonds definition is completely the same as a normal bond except for the fact that the face values are less than $1,000. They typically come in denominations of $500 or $25.

Baby Bonds Meaning

A baby bond has two special purposes. First, a baby bond are able to bring smaller investors into the market allowing companies to benefit from another source of cash. The second purpose is to provide funding for smaller companies who do not have access to the larger institutionalized markets.

Baby Bonds Example

Look at the following baby bonds example. Sarah has $600 that she would like to invest in debt instruments. However, the amount is not enough for her to invest in a bond with a $1,000 face value. She hears about baby bonds from a friend and decides to invest in one $500 face value bond and four $25 face value bonds. Both of them pay the same interest rate at 5%, semi-annually. This is much more beneficial to Sarah because she can get a higher interest rate through a baby bond than she can when she is investing in a certificate of deposit or savings account.

baby bonds, Baby Bonds Definition, Baby Bonds Example

baby bonds, Baby Bonds Definition, Baby Bonds Example

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