Advantages and Disadvantages of Trades Receivables

Advantages of trade receivables

1. Trade receivables are not counted in the balance sheet because they are not replaced by their cash equivalent, and this improves the financial statement of the originator.

2. There is no need for the originator to wait for payments to be received from the receivables. Thus, the originator can continue getting profits even when the payments are not made immediately.

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

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

5. It allows investors the opportunity of trading 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 capable of realizing their values.

2. As a result of the high level of flexibility, the securitization process can be used to securitized anything from credit cards to even mortgages. Thus, an accomplishment record in the region of 3-6 is required in order to be a creditable receivable pool. Additionally the loan guarantee terms are automatically reduced because the person seeking such securitization needs to have a predictable and stable source of cash flow.

Steps to ensure repayment

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

1. Having clear resolving period – under normal conditions, typical trade receivable pools will liquidate in the space of two to three months, if the pools are relatively constant and all the collections are adopted for the purpose of paying down debts. Thus, the investors need to have a clear, structured and agree resolution period for any trade receivables.

2. Early amortization events – in order to increase the credit quality of the transaction, early amortization are adopted to discount revolving interest-only period if the reinvestment of investors cash flow becomes significantly less desirable and this can increase repayment because reduction in interest will increase speed of repayment.

3. Cash flow allocation – most of the trade receivables are based on borrowing base concept. In this approach, investors entitled to receive a percentage of the collection that is equal to the amount invested over the borrowing base. Thus, it increases repayment to all investors in equal terms and increases overall repayment period.

4. Eligibility criteria – this defines the conditions for the pool and limits investors to high risk receivables, thus reducing and potentially eliminating issues associated with lack of repayment as the investors that don’t meet the criteria will not participate in the pool.