Off-Balance Sheet Financing Usually Is Found In Connection With Advantages and Disadvantages of Trades Receivables

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Advantages and Disadvantages of Trades Receivables

Benefits of trade receivables

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

2. No need to wait for originator to receive payments from receivables. Thus, the originator can continue to receive profits even if they are not paid immediately.

3. Securities are rated very highly by rating agencies. This reduces the huge interest associated with lower ranks.

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

5. It offers investors an opportunity to trade in capital markets that have better funding costs.

Disadvantages

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

2. As a result of its high degree of flexibility, the securitization process can be used to secure anything from credit cards to mortgages. Thus, an achievement record in the area of ​​3-6 is essential to have a reliable receivables pool. Additionally, loan guarantee terms are automatically reduced because the person seeking such security needs to have a predictable and stable source of cash flow.

Steps to ensure payment

Stanford and Poor’s Rating Services (n.d.) may take the following steps to ensure payment:

1. Having a clear solution period – Under normal circumstances, normal trade receivables pools will be exhausted within two to three months, provided the pools are relatively stable and all collections are adopted to pay off the debt. Therefore, investors need to have a clear, structured and agreed resolution period for any trade receivable.

2. Early amortization events – In order to increase the credit quality of the transaction, early amortization is adopted to discount the revolving interest-only period if the reinvestment of the investors’ cash flow is significantly less desirable, as the reduction in interest speeds up the repayments, thereby increasing the reinvestment.

3. Cash Flow Allocation – Most trade receivables are based on the borrowing base concept. In this approach, investors are entitled to receive a percentage of the collection equal to the amount invested on a loan basis. Thus, it increases the payout to all investors on equal terms and increases the overall payback period.

4. Eligibility criteria – It defines the terms of the pool and limits investors to high risk receivables, thus investors who do not meet the criteria will not participate in the pool.

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