Advantages and disadvantages of trade receivables

Advantages and disadvantages of trade receivables

Advantages and disadvantages of trade receivables

Advantages of trade receivables

1. Trade receivables are not reported on the balance sheet because they are not replaced by their cash equivalent and this improves the originator’s financial statement.

2. There is no need for the originator to wait for the receivables to be paid. In this way, the originator can continue to receive profits even when payments are not made immediately.

3. Securities are ranked much higher by rating agencies. This reduces the huge interest associated with the lower ranking.

4. Assets and other liabilities can be coordinated and this eliminates the need for dividends.

5. Enables investors to trade in capital markets that have better funding costs.

Disadvantages

1. Trade receivables increase costs. This is because receivables can only be securitized when the securitization process is able to realize their values.

2. As a result of the high level of flexibility, the securitization process can be used to securitize anything from credit cards to even mortgages. Thus, a track record in the region of 3-6 is required to be a creditable receivables pool. In addition, the conditions for guaranteeing the loan are automatically reduced, as the person seeking such securitization must have a predictable and stable source of cash flow.

Steps to secure payout

Stanford and Poor’s Rating Services (nd) provides steps that can be taken to ensure repayment such as:

1. There is a clear resolution period – under normal conditions, typical trade receivables pools will be liquidated within two to three months if the pools are relatively constant and all collections are accepted to pay off debts. As such, investors should have a clear, structured and agreed upon resolution period for any trade receivables.

2. Early Depreciation Events – in order to increase the credit quality of the transaction, early amortization is adopted to reduce the period of revolving interest if the reinvestment of the investors’ cash flow becomes significantly less desirable and this can increase the payout, since the reduction in interest will increase payout speed.

3. Cash flow distribution – most of the trade receivables are based on the concept of loans. In this approach, investors are entitled to receive a percentage of the collection that is equal to the amount invested over the loan base. In this way, it increases the payoff to all investors under the same conditions and increases the total payback period.

4. Eligibility criteria – this defines the terms of the pool and limits investors to high-risk claims, thus reducing and potentially eliminating problems related to non-repayment, as investors who do not meet the criteria will not participate in the pool.

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