Why would a company sell its receivables to another company?

• A. To quickly generate cash and improve liquidity
• B. To increase the total amount of receivables on its balance sheet
• C. To avoid recognizing revenue from sales
• D. To reduce its inventory levels

Answer: (A)

Verified step by step guidance

1. Understand the concept of 'selling receivables': Selling receivables, also known as factoring, is a financial transaction where a company sells its accounts receivable (money owed by customers) to another company, typically a factoring company, at a discount.
2. Identify the primary reason for selling receivables: Companies often sell receivables to quickly generate cash. This is particularly useful for improving liquidity, which refers to the ability of a company to meet its short-term financial obligations.
3. Evaluate the incorrect options: Selling receivables does not increase the total amount of receivables on the balance sheet; instead, it removes them from the company's books. It also does not help avoid recognizing revenue from sales, as revenue is recognized when the sale occurs, not when receivables are sold. Lastly, selling receivables does not directly reduce inventory levels, as inventory is unrelated to accounts receivable.
4. Connect the correct answer to financial strategy: By selling receivables, a company can convert outstanding invoices into immediate cash, which can be used for operational needs, debt repayment, or other financial priorities. This is a common strategy for companies facing cash flow challenges.
5. Summarize the rationale: The correct answer is 'To quickly generate cash and improve liquidity,' as selling receivables provides immediate funds and enhances the company's ability to manage its short-term financial obligations.