Avoiding potential problems when selling accounts receivable - accounts receivable financing

Healthcare Financial Management, May, 1996 by Donald H. Ayers, Timothy J. Kincaid

PATIENT ACCOUNTS MANAGEMENT

Accounts receivable financing is a potential tool for managing a provider organization's working capital needs. But before entering into a financing agreement, organizations need to consider and take steps to avoid serious problems that can arise from participation in an accounts receivable financing program.

For example, the purchaser may cease purchasing the receivables, leaving the organization without funding needed for operations. Or, the financing program may be inordinately complex and unnecessarily costly to the organization. Sometimes the organization itself may fail to comply with the terms of the agreement under which the accounts receivable were sold, thus necessitating that restitution be made to the purchaser or provoking charges of fraud.

These potential problems should be addressed as early as possible - before an organization enters into an accounts receivable financing program - in order to minimize time, effort, and expense and maximize the benefits of the financing agreement.

Prior to the late 1980s, accounts receivable purchase programs were of limited use and availability to provider organizations because retrospective reimbursement practices dominated the healthcare industry. Accounts receivable financing programs began to appear when prospective reimbursement policies forced provider organizations to become more adept at managing their financial resources. The drive toward managed care only has accelerated the need for creative financing mechanisms to improve cash flow as well as fund asset acquisitions and joint ventures.

The growth of accounts receivable purchase programs initially was slow, in part because executives believed the sale of accounts receivable would be perceived as a sign of financial weakness in their organizations, and in part because this type of financing mechanism was not well understood in the industry. Since 1990, however, there has been a market for accounts receivable purchase programs among healthcare providers that recognize the need for a vehicle for improving cash flow. An increasing number of nursing homes, home health care providers, psychiatric/alcohol and substance abuse facilities, and acute care hospitals are entering into receivables purchasing programs.

Benefits for providers

The objective of an accounts receivable purchase program is to provide immediate funds to healthcare providers so they do not have to wait to obtain capital until receivables are collected. The resulting acceleration of cash flow allows the provider to reduce payables, prepay accounts to obtain discounts, or pay off tax liens and other debts that threaten the financial stability of the business. It also improves the balance sheet. With a properly structured sale of accounts receivable, a provider can remove from its balance sheet the receivables that have been sold and substitute cash without recording any significant liability other than the liabilities that may arise as a result of failure to comply with the terms of the sale agreement.(a) In addition, accelerated cash flow provides a source of funds from which the seller can make acquisitions of other businesses, real estate, or equipment.

The availability of this type of financing also is important to providers because it provides funds when existing covenants restrict additional funded debt or when other sources of financing are unavailable because of the organization's poor financial condition. The financial condition of a provider organization is significantly less important to a purchaser of receivables than it is to a lender. Unlike a loan from a lender that is secured by accounts receivable, the purchase of receivables insulates the purchaser from a provider's bankruptcy. For example, accounts receivable that have been sold are not part of a provider's bankruptcy estate. The purchaser therefore does not have to adhere to the automatic stay that is imposed by bankruptcy laws. The purchaser also is not subject to the loss of any overcollateralization that may have been structured into the financing program.

Program structure

Accounts receivable purchase programs differ in complexity and cost; however, from the perspective of the healthcare provider, their basic structure is fairly standard. Under a purchase program, a provider organization sells its accounts receivable to an entity that has been established for the sole purpose of purchasing the receivables. Usually, the purchasing entity is controlled by the bank or firm that sponsors the program, and the entity funds purchases by using the receivables as collateral for loans or investments from third parties or from an affiliated company. The purchasing entity on occasion may be controlled by the healthcare provider. In such circumstances, the entity obtains funds for the purchase of receivables through loans made by the program sponsor.

Typically, as a result of the sale of accounts receivable, a provider receives a sum ranging from 50 percent to more than 80 percent of the expected value of the receivables upon closing of the sale. All or a portion of the remaining expected value of the receivables is handled in one of four ways: as a (1) deposit in a reserve account that is controlled by the purchaser; (2) subordinated participation interest in the receivables that now are owned by the purchaser; (3) secured or unsecured claim against the amount that is to be collected by the purchaser; or (4) a combination of these options. In programs utilizing reserve account deposits, the amount received by the seller at closing plus the amounts that are deposited generally are equal to 97 percent or more of the expected value of the receivables.