Eligible Receivables: a Worked Example

A financier lending against a ledger wants debts that are real, owed for goods already delivered, payable on known terms, free of other claims and collectable by someone else. Most exclusions follow from one of those. An invoice unpaid well past its terms has told the financier something. A debt owed by an associated company can vanish by book entry and may fail with the borrower. A customer that is also a supplier may pay only the net. A balance for work not finished or not invoiced is not yet a debt.

The agreement states the rules, and they vary by lender, industry and the borrower's condition. The US national-bank supervisor's handbook gives a general test, that the receivable arises in the ordinary course of business and is subject to a perfected first-priority security interest in the bank's favour, and lists the usual exclusions. Financiers in New Zealand, Australia and the UK work from broadly similar lists, set facility by facility.

Order matters. An invoice is removed once, so each test works on what the last one left, and concentration usually comes last because it is measured against a pool already cleaned. Cross-ageing and contra have their own pages. A concentration limit is set per customer and can be negotiated up for a strong one.

Contract terms can also disqualify a debt. A clause banning assignment can stop a financier collecting an invoice in its own name. In England and Wales, regulations covering contracts made on or after 31 December 2018 generally make such bans ineffective where the supplier is not a large enterprise, subject to a list of excluded contracts. In Australia the Personal Property Securities Act leaves such a term binding on the supplier only as a liability in damages and unenforceable against third parties, for the whole of most trade accounts, with construction-contract rights among the exceptions. Elsewhere the effect turns on statute and drafting, so a financier's lawyers read the customer terms.

A manufacturer of acoustic ceiling panels sold to fit-out contractors, constructed for this page like every figure in it, has debtors of US$12.0m and a facility advancing 85% of eligible receivables. In US$000, on the agreement's own rules, which belong to the example and are not a market norm:

Applied to the face of the ledger, 85% would have been US$10.2m. The agreement produces US$6.02m, just over half the ledger. The largest deduction is concentration, and it comes from the business succeeding: one national contractor has grown to more than a third of the ledger.

The drafting of the limit moves the answer. Had the agreement measured 30% against the gross ledger, as some do, the limit would be higher:

The debtors figure in the accounts is a different measurement made for a different purpose. Accounts report what the business expects to receive after a provision for doubtful debts, and that provision is a judgment about loss. Eligibility is a contractual filter that removes debts even when the business expects to collect them in full. A related-company balance may be perfectly good; it is still out. The aged debtors report is the raw material, which is why a lender reconciles it to the ledger line by line.

Eligible receivables is also only one input to a borrowing base, which goes on to apply advance rates, add any stock and take off reserves. And dilution is not tested invoice by invoice: it is an allowance for credits that no eligibility rule can see in advance. Selective invoice finance works from the other direction, starting with one named invoice and approving that debtor.

DEFINED IN ONE PARAGRAPH → · THE CERTIFICATE, LINE BY LINE → · INVOICE FINANCE →

A business that plans around a headline limit can find the cash is not there. The usual moment is growth. A supplier wins a national customer, sales rise, the debtors line rises and availability barely moves, because the new balance goes straight into the concentration excess. Exporters meet the same thing when the ledger moves overseas. In Issue 13 the senior read arrives at a receivables base in which only insured paper is eligible, and in Issue 02 the eligible figure is the share of the US dollar ledger inside 90 days.

For the lender, a tight definition does a job a lower rate cannot: it takes out the debts most likely to disappoint and leaves the rate higher on the rest. For the borrower, eligibility is often negotiable where the rate is not. Credit insurance can bring overseas debts in, a named customer with a strong balance sheet can be given a higher limit, and an agreed age test can reflect a slower-paying industry. The definitions deserve reading before the headline.