When a company is looking to fund its growth from outside sources, one particular aspect of their business is a good candidate for use as collateral – the invoice.
An invoice is an obligation to pay from an account debtor, meaning, your business has done some work and now the receiver owes you money. Whenever a company extends credit for work it in essence becomes a banker. The company is lending their customer money – usually interest-free for the period of time it takes for the customer to pay off the note.
There are two conditions an invoice must have to be considered a bona fide asset to be used as collateral for a loan. The first is “work completed and accepted.” This means the customer can sign off that they are completely satisfied with the job they hired the company to do and will say so, either verbally or by written verification depending on the circumstances. Situations where the work has begun and normally the customer allows the company to go ahead and send in an invoice to get it into the system will not stand up to a verification process associated with receivables finance. The terms of payment must be clear and work must be done to be true collateral.
The second condition is “credit worthy.” An invoice to a customer that has little or no credit is not considered an asset and cannot be used as collateral. The critical distinction here is, even if the work is done for a government agency but is being billed through a prime contractor – that contractor is the account debtor and must be considered creditworthy. Too often the prime is just a go between to secure a contract by and has no assets themselves and no credit history. This creates a problem when considering invoices to that prime as collateral for a loan.
The lesson here is, act like a banker and make sure your loans (invoices) get paid on time and be sure you are extending credit to customers who can qualify for it.