Can someone explain the concept of why you would want to finance or securitize payables or receivables and the consequences.
Generally you would finance payables or securitize receivables for cash flow reasons. Obviously this comes with the cost of either interest or factoring (i.e. discount on the amount paid based on the riskiness of the recievable) on the payment and therefore has its consequences. A business will normally go down this path if the cost of doing so is as cheap or cheaper than other forms of financing (or if they are in trouble with cash flow). It’s been 2 years since I studied this at Level I, but from memory the point of discussing it in the Level I text is that such a decision will have impacts on balance sheets and cash flow statements and therefore has to be considered when comparing 2 companies in identical positions but in which one uses such strategies and the affects this will have on the statements and associated ratios that are calculated on these statements.
Securitization is a method of generating funds. The choice of using this source depends upon either its cost effectiveness or non availability of other sources. This method is considered a temporary measure. The amount generated against securitization depends upon the risks associated with the assets being held as collateral and their quality.
Phril - think in terms of the cash flow statement. Let’s talk about financing payables, for example. Your CFO is low because of the “drags/pull” on liquidity - i.e., you’re unable to meet your short-term obligations in a timely manner. One option management has is to take out a loan from a bank and payoff the short-term A/P obligations to boost CFO. In essence, you “shifted” cash flows from operations in the current period. A/P will go down because the proceeds from the bank loans were most likely used to pay off your short-term obligations. Effectively, the repayments for the bank loan will be recorded under the financing section in the future periods, giving investors the impression that the company’s CFO is gold. Hope this helps.
Thanks oyster! That makes more sense. I have a question regarding the same subject: financing payables reduces accounts payables, decreases days s payable and lengthens the cash conversion cycle. Why does it lengthen the cash conversion cycle, isn’t it the purpose of financing it"? Thank you in advance