The first method is pledging the account receivable as collateral for a loan.
So, instead of waiting for the customers to pay you to get the cash, you could go
out to a bank and borrow money today with those accounts receivable as collateral.
Then you would still have the accounts receivable, and
you would have to collect those receivables so that you could use the cash
to pay the bank loan and the collateral is there cause if you default on the loan,
then the bank would seize the receivables as collateral.
Now in this case the company is taking the risk of collection,
which they may not want to do.
So there's another way that reduces this risk called factoring.
Under factoring what the company would do is sell the accounts receivable to
a bank at a discount, and that discount reflect both an interest charge and
the risk of uncollectibility.
So let's say you had a million dollars in accounts receivable.
You'd have to wait 30 to 90 days to collect that million dollars.
Instead, you could sell those accounts receivable to a bank, for say $950,000.
You get your cash right away, and
you don't have to worry about collecting the receivables.
Now the reason the bank is paying you $950,000 instead of a million.
Is that part of that reflects an implicit interest charge,
because now the bank has to wait to get the money back.
And part of it reflects the risk of the receivables being uncollectable because
the bank is now taking on that risk.