Definition of a Receivables Purchase Agreement

Receivables arise when a company sells something but doesn't immediately receive payment -- a classic "bill me later" transaction. The company gives the customer an invoice for payment, perhaps offering a discount if the customer pays quickly.

Companies typically book sales revenue whenever a sale is made, even if it has not yet received payment. Until payment arrives, the revenue from sales appears on the ledger as accounts receivable. When customers pay their bills, the amount paid shifts from accounts receivable to cash. In the meantime, though, the company waits -- and hopes that the customer doesn't default.

Rather than wait to collect outstanding accounts receivable, a company can sell its receivables to someone else, usually at a discount. The company gets cash upfront and doesn't have to deal with the hassle of collecting or the uncertainty of waiting. Receivables can be a major asset of a company; the quicker they're converted to cash, the quicker the company can use that money for something else.

A shoe store is in business to sell shoes. A restaurant exists to sell meals. Neither is in business to collect outstanding debts. Other companies, however, specialize in it. If such a firm could buy receivables at, say, 90 cents on the dollar and then collect the full amount of the receivables, it would make a nice profit. Financial institutions are also frequent purchasers of receivables. They can hold them as assets or package receivables from many companies together and sell shares of the package to investors looking for a steady stream of income.

Receivables purchase agreements set up a contractual framework for sales of accounts receivable. A company may choose to sell all of its receivables under a single agreement, or it may choose to sell an undivided interest in its pool of receivables. Accounts-receivable purchase agreements are usually multiparty contracts, with one company selling the receivables, another party buying them, and additional companies serving as servicers and administrators. The contract spells out the terms of the sale -- who pays what, and when; who receives what, and when; and what each party's responsibility is.