Often, firms have cash tied up in working capital, which can be put to good use via receivables financing. The product lends itself well to the requirements and challenges faced by corporate treasurers. It provides a solution that can achieve off-balance sheet treatment, provides an additional source of liquidity, diversifies funding sources and allows you to retain control of customer relationships.
Below, we explore the basics of receivables finance, its various forms, and how it can empower corporate treasurers to navigate the ever-changing financial landscape.
The basics
Trade receivables are the most liquid asset on a company's balance sheet, after cash. They represent the money you have earned but cannot yet spend. With the right financing product to monetise these assets, a corporate can poise itself strategically to meet its immediate challenges and growth aspirations.
Trade receivables finance is the process of raising cash by selling or assigning the receivables to another institution, usually a bank or a non-bank lender. A funder will typically finance a percentage of the face value of the trade receivables.
Common forms of receivables finance products
- Receivables securitisation: generally suitable for a relatively granular and diverse pool of customer receivables of at least $50-75m+ and preferably without significant customer concentrations (although structural tweaks can be available to deal with this). The structure often uses an SPV to buy and sell receivables.
- Receivables purchase or monetisation: suitable for a concentrated customer pool of only a few names wherein the credit risk analysis is generally on a customer name-by-name basis. You can consider this product for even part of your accounts receivables portfolio, which may have a concentrated profile.
- Receivables portfolio purchase: appropriate for a somewhat more diverse pool of customers and typically uses credit insurance for risk mitigation. The funder may restrict funding availability for debtor names up to credit insurance limits. Factoring and invoice discounting facilities tend to fall under this category.
- Buyer’s supply chain finance (SCF or reverse factoring): supply chain finance (SCF) programmes to which suppliers sign up to typically leverage the credit rating of their buyer for cheaper financing rates and additional liquidity.
- Loan against assets or asset-based lending (ABL): the lending of money against assets such as inventory, receivables, and other assets as collateral, also often known as borrowing base facilities.
Why do companies consider receivables finance?
- Improved cash flow: It provides quick access to cash, allowing companies to optimise working capital by monetising the trade receivables’ assets on the balance sheet. A company can improve its working capital by unlocking the cash in unpaid invoices. This extra liquidity can fund day-to-day operations, support growth opportunities, pay suppliers promptly, and cover unexpected expenses.
- Non-recourse off-balance sheet treatment: The sale of receivables can be structured as non-recourse and off-balance sheets (subject to the company auditor’s approval). This can help with improving metrics such as net debt/EBITDA. However, please note that rating agencies typically consider receivables’ financing exposures in their calculations.
- Risk mitigation: Transferring customers' credit risk via the sale of invoices to a funder, which assesses the creditworthiness of the debtors.
- Scalability: It is scalable, meaning it can grow with your business. Facility sizes tend to grow with any inorganic or organic business growth. As a company's sales and customer base grow, it generates more accounts receivable (unpaid invoices). Receivables finance is scalable because a company can increase the volume of invoices it chooses to finance (subject to funder appetite) or, depending on transaction structure, add any newly acquired subsidiaries to the structure.
- Flexibility and cost of financing: Depending on your company's specific needs, you can choose between various receivables financing products and features within, tailoring the financing method to fit your cash flow requirements. Often, as these facilities are ‘asset-backed’, they tend to be cheaper than senior financing.
- Monitoring of asset performance: An additional benefit of having receivables financing in place is that assets performance data is gathered at the required frequency (from daily to monthly, depending on the funder's ask) for reporting. This brings to light the deterioration of the performance of trade receivables.
Key considerations for corporate treasurers
There can be many factors to consider before embarking on such a project, such as:
- Strategy: Consider how receivables finance fits into your broader treasury and financial management strategy. It should align with your overall financial goals.
- Objectives: When considering such a financing product, it is essential to identify and outline the objectives behind the exercise. This will affect the type of product and funder to be selected for financing. Objectives can include requirements such as lowering financing cost, additional liquidity, desired accounting treatment, credit risk transfer.
- Internal buy-in: Receivables financing is a strategic decision, and to achieve success, it requires buy-in from various parts of the firm. While the Treasury, Finance & Control departments may lead discussions with funders and external parties, multiple parts of the organisation typically provide valuable contributions to the successful execution of the facility.
- Cost: Assess the costs associated with receivables finance carefully. Different methods have different pricing structures, including upfront fees, ongoing margin, factoring, and commitment fees, if applicable. It's crucial to compare and understand these costs and their calculation basis with other financing alternatives available.
- Scope: It is advisable to consider the transaction scope early. This means carefully looking at the company group structure to see which entities may be suitable and can be included in a transaction. Scoping can also be in terms of debtor names to be included. In some cases, due to contract restrictions or being part of debtors’ SCF programs, certain debtors may have to be excluded.
- Legal and regulatory compliance: Be aware of any restriction in your senior financing documentation preventing you from undertaking receivables’ financing for all or part of the portfolio.
- Data readiness: A key pillar of any receivables financing is regularly reporting requirements from a seller to the funder. Required information is extracted from ERP. This area can be supported by a reporting services provider such as Demica.
- Resourcing: It is fair to acknowledge that upfront work is required to set up such facilities. However, once the upfront groundwork has been done, the facility operations can be managed relatively smoothly, and the benefits generally far outweigh the effort put in. For ongoing transaction reporting, one or more of the required tasks can be outsourced to external advisors, such as legal counsel for legal documentation.
About the author
Shikha Kalra is senior director of working capital solutions at Demica
Demica offers a comprehensive solution in terms of advisory, distribution and technology services, to help its clients meet their objectives. If you are considering this financing in the near term, the Demica team would be delighted to help you determine the feasibility of the most appropriate solution for your needs and support finding the right funding partner for your receivables financing programme.
For more information about Demica and its receivables finance solutions – download its working capital guide here.
Disclaimer: This content is a marketing communication provided for informational purposes only. It is educational in nature and not designed to be taken as advice. All opinions are the author’s own.
