What is Accounts Receivable Discounted?

Accounts receivable discounted are unpaid billings to customers that have been sold to a third party in exchange for cash. These billings are sold off at a reduction from their face value so that the seller can gain immediate access to cash, thereby improving its cash flow. The buyer of discounted accounts receivable is known as a factor, and earns back the money paid to the seller of the receivable by collecting the receivable. The factor is at risk of loss if it cannot collect on a receivable, since the seller is not liable for uncollectible billings.

The discounting of receivables can be quite expensive for the seller of receivables, so this is considered to be a lesser financing strategy for most firms. It works best when a company earns a high margin on its sales, so that it can absorb the large discounts applied by factors.

Advantages of Accounts Receivable Discounting

The main advantage of accounts receivable discounting is that it greatly accelerates the receipt of cash. This is especially important when customers are not paying for extended periods of time, such as 60 to 90 days from the invoice date. In these cases, the seller needs funds to support its operations until its invoices are paid - and discounting is a great way to obtain short-term cash.