Introduction to Finance

DISCUSSION QUESTION 2
How will receivables fi nancing methods—from either banks or other sources—aff ect how 
accounts receivable are managed, as we learned in the Chapter 15 Learning Objective 7?
LEARNING ACTIVITY
Learn about factors and other asset-based lenders by visiting websites such as http://
www.gecapital.com, http://www.gecdf.com/home, http://www.textronfi nancial.com, and 
http://www.celticcapital.com.
16.6
Inventory Financing and Other 
Secured Loans
Accounts receivable fi nancing is a method of fi nancing a creditor’s promise to pay for goods 
already obtained. On the other hand, inventory represents goods that are “on the premises,” 
which provides additional security in case of borrower default. Other forms of security for 
business loans can include fi nancial securities, such as stocks and bonds, that are owned by 
the business or its owners. For smaller businesses, an owner’s cash value of a life insurance 
policy can be used as loan security, or the fi nancing source may want the owner to personally 
guarantee the loan. 
18
For an example of this in the Chinese economy, see Dinny McMahon, “China Cash Shortage Brings IOUs to Fore; 
Use of Acceptance Drafts Grows as Economy Slows, Banks Hesitate to Lend,” 
The Wall Street Journal, 
(April 4, 
2014), pp. C1, C2.
TA B L E 1 6 . 2
Comparison of Pledging and Factoring Accounts Receivable
Pledging Accounts Receivable
Factoring Accounts Receivable
It is a loan against accounts receivable
It is a sale of accounts receivable
Accounts receivable balances remain on 
the balance sheet
Accounts receivable balances are removed
from the balance sheet
Customer pays the firm, which submits 
the payment to the bank
Customer pays the factor
Firm makes each credit decision
Factor makes the credit decision; firm can 
choose to extend credit on its own
Charges:
• interest rate on loan
• audit fees for periodic review of 
accounts, payments
Additional cost: paper and funds flow
between firm and bank
Charges:
• interest rate on funds advanced
• service charge

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16.6 Inventory Financing and Other Secured Loans
513
Inventory Loans
A business may use its inventory as collateral for a loan in much the same manner that it may 
borrow on its receivables. The bank evaluates the physical condition of the fi rm’s inventory 
and the inventory’s general composition. Staple items that are in constant demand serve well 
as collateral for loans. Style and fashion items, such as designer clothes, are less acceptable as 
collateral, except for brief periods. Firms that use inventory as collateral usually do so because 
they are not in a position to obtain further funds on an unsecured basis.
The bank may protect itself when lending to a business by having a