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Receivables Finance | What You Need to Know
For businesses looking to smooth cash flow or expand, accounts receivable can present a problem: accounts receivable is the money that is owed to the company by its customers from sales or services already rendered, and delays in its being realised puts pressure on the day-to-day finances of a business.
Receivables finance covers a range of products that are designed to specifically alleviate some of this pressure, giving businesses the chance to manage cash flow or release capital for expansion that is otherwise temporarily locked as accounts receivable.
With years of experience, Clifton Private Finance can help you understand the world of receivables finance and how you can leverage it to your business’s advantage.
What is Receivables Finance?
Receivables finance provides a way to leverage accounts receivable for funding, either through a loan or revolving line of credit, or by selling the accounts receivable as an asset to a third party.
As accounts receivable is considered an asset on the balance sheet, it can be leveraged in the same way as physical assets to secure funding, opening the door to a range of asset-based lending (ABL) options as well as specialised products developed with accounts receivable at the core.
Receivables finance presents businesses with a way to get their money early, working around the sometimes lengthy credit payment terms that they must offer customers to remain competitive.
Examples of receivables finance include:
- Invoice factoring
- Asset-based lending with accounts receivable
- International forfaiting
- Letter of credit discounting
- Supply chain finance
Why Use Receivables Finance?
Cash flow is of constant importance to businesses no matter their size.
In order for a company to grow, credit must often be provided to customers and clients in terms of work undertaken or goods sold prior to the full payment of those services or products.
Managing the day-to-day outgoings of the business while waiting for that extended credit to be realised can be difficult. Without substantial working capital, businesses will struggle to pay salaries, meet overheads, and have the money needed to invest.
For a reasonable fee, receivables finance fills this gap, providing the money today that you know will be paid tomorrow.
Typically receivables finance is used for:
- Covering salaries and wages
- Buying equipment needed for new projects
- Purchase of stock
- Cash flow for ongoing overheads
Unique Aspects of Receivables Finance
Receivables finance is a range of specialist products that involves 4 main considerations that are not part of other business finance products:
Transparency
Some receivables finance options are disclosed, which means that the business’s customers will be aware that it is being used.
These transparent arrangements can have a negative affect on the supplier-customer relationship, causing some customers concern, and even risking a misunderstanding the nature of the finance agreement.
It is not unheard of for customers to confuse the use of receivables finance with credit control measures and debt collection.
It is essential that you fully understand the level of disclosure and confidentiality in any receivables finance product to ensure there are no unwanted repercussions.
See also: Confidential Invoice Finance
Loan Structure vs. Sale of Receivables
Receivables finance comes in two distinct forms:
- Products that are structured as a business loan or revolving line of credit facility, secured with the asset of accounts receivables
- And products that are the sale of the accounts receivable to a third-party finance company.
The latter are those that are transparent, with the end customer fully aware that their debt has been sold on.
Credit Control
A third consideration is that of credit control, known as recourse or non-recourse financing.
When the financing is non-recourse, the finance company takes over the aspect of credit control and much of the risk involved in obtaining the payment from the customer.
Finance company credit control with a non-recourse receivables finance product is not the same as employing a debt collections agency and though they will utilise their efficient administration, the final responsibility for the debt often still resides with you as the debtor to the finance company.
In a recourse agreement, on the other hand, you are fully responsible for credit control and chasing the customer for any late payment. In these instances, delays could incur additional interest or fees on the receivables finance.
One Time or Revolving Line of Credit Facility
Receivables finance can be an extremely flexible and ongoing form of funding for businesses, with support from the lender throughout.
In many cases, businesses choose to opt for a long-term revolving credit facility whereby you are extended a credit limit (tied to your business turnover and average accounts receivable value) and can dip in and out of that credit as needed.
With an accounts receivable revolving line of credit, any new invoices can be immediately drawn upon once issued.
A one-time receivables finance product, on the other hand, is a single-use product, such as a loan drawn against an invoice, that is cleared fully once the invoice is paid.
5 Types of Receivables Finance
Many types of receivables finance exist for both domestic and international solutions.
The following 5 are the more common products used:
Invoice Factoring
One of the main types of receivables finance, invoice factoring involves the sale of unpaid invoices to the lender, known as the factoring company or factor.
It is a transparent sale arrangement where the credit control responsibilities transfer to the factor. Factoring can be either whole, involving all unpaid invoices, or selective, where only a selection of unpaid invoices are factored.
See also: Selective Invoice Finance
Invoice factoring is often structured as a revolving credit facility, with funds becoming available as outstanding invoices are factored and a credit limit based on your company turnover.
Factoring costs include:
- The factoring fee or discount rate, often ranging from 1% to 5% of each invoice;
- A setup fee and annual administration fee;
- And, in some cases, additional interest rate on the credit balance, as well as potential fees for credit control.
Invoice Discounting
Another common form of receivables finance, invoice discounting is structured as a loan that is secured with the accounts receivable asset of unpaid invoices. In many ways, discounting follows the structural nature of factoring, with whole and selective options, and the choice between a single loan or the creation of an ongoing line of credit facility.
See also: The Advantages and Disadvantages of Invoice Discounting
Unlike factoring, however, invoice discounting is a discrete process with credit control remaining wholly with you, and the customer unaware of the arrangement. In this way, it is like any other business loan.
Invoice discounting is a loan, subject to interest rates. Setup fees and monthly or annual administration fees form additional costs for a revolving credit facility.
Asset-Based Lending (ABL)
Asset-based lending (ABL) covers a range of products that form secured loans using a range of company assets as collateral.
Unlike invoice discounting - a specialised form of asset-based lending solely leveraging accounts receivable - ABL often uses accounts receivable alongside other tangible assets, such as vehicles, equipment, stock, or machinery, to create a package of assets that can be used as collateral to secure a larger loan.
Like other forms of receivables finance, ABL involving accounts receivable can be offered as a single loan or a longer-term revolving credit facility, with a similar interest rate and fee structure to invoice discounting.
Forfaiting
Primarily used in international trade finance, forfaiting is similar to invoice factoring: selling accounts receivables that are owed by foreign customers, and backed by promissory notes or letters of credit.
It is designed to mitigate risk and provide immediate payment of international invoices for exporters.
Letter of Credit Discounting
In international trade, Letters of Credit (LCs) are issued by the customer’s (importer’s) bank as a security to mitigate the risk of internationally shipping goods prior to being paid.
For an exporter holding a letter of credit but looking to access the money sooner, letter of credit discounting offers a solution.
Similar to invoice discounting for unpaid invoices, LC discounting is a form of receivables finance that secures a loan leveraging the bank guarantee provided by the LC as collateral.
Alternatives to Receivables Finance
Receivables finance covers products designed for suppliers of products or services to smooth cash flow and provide funds while waiting to be paid by customers.
However, additional systems and products exist that look at the issue from different perspectives, offering solutions with substantial flexibility.
Here are 4 similar alternatives:
Supply Chain Finance
Supply chain finance, sometimes called reverse factoring, is a system where the buyer arranges financing to ensure their suppliers are paid sooner.
With supply chain finance, the buyer utilises a finance company to pay the supplier's invoice swiftly. The supplier gets paid right away, while the buyer can take advantage of the payment terms without causing cash flow issues for the supplier.
The buyer then repays the finance company at the end of the agreed invoice term, typically with interest.
This way, the buyer retains access to its capital for longer, while suppliers benefit from timely payments. Supply chain finance is effective when the buyer’s credit history is particularly strong as the financing costs are low and worth the flexibility it offers.
Purchase Order (PO) Finance
Purchase order finance is financing that is leveraged against a customer’s purchase order, used at the early stage of a project or sale to obtain the capital needed to buy stock or cover overheads where existing capital is insufficient.
Like receivables finance, PO finance uses the leverage of an intangible asset (in this case, the customer’s confirmed purchase commitment) to obtain funding at a competitive rate.
Dynamic Discounting
If the customer has the cash available to pay the invoice before it is due, they may offer dynamic discounting.
Dynamic discounting can also be offered by the supplier, for example with a 5% discount applied for invoices paid within two working days of issue. This encourages prompt payment and solves cash flow issues.
Dynamic discounting puts the customer’s existing capital to good use, providing a financial incentive for prompt payment if possible. Effectively it works as a risk-free return on investment for the customer and affordable financing for the supplier.
As an arrangement between supplier and customer, dynamic discounting can take the form of a one-off deal, or an ongoing arrangement for continued swift payment.
Buy Now, Pay Later (BNPL)
Another similar option lies with buy now, pay later (or BNPL) for businesses.
This is the system of offering direct customers, such as online buyers, a simple way to spread the cost of payments over time and is typically done through specialist third-party financiers, such as Klarna, PayPal, or Clearpay.
With BNPL, customers are able to afford higher-priced goods today and pay the finance company over time. The majority of BNPL deals do not charge interest to the customer; instead, they make their profit by charging a fee to the supplier for the service.
Pros and Cons of Receivables Finance
In all its forms, receivables finance has a clear goal - to provide capital today when payment is clearly promised for tomorrow.
It smooths business cash flow and makes sure that you can bridge the gap between the moment you invoice your customer and the day they finally pay.
Like any financial product, receivables finance has its advantages and disadvantages:
PROS
- Access to tied-up money instantly - Many receivables finance applications can be processed and completed within a day.
- Long-term revolving credit facilities for future use - Once set up, a line of credit can be used as needed to backup cash flow.
- Enable expansion for stock and projects - Using the money freed up through receivables finance, you can keep investing in stock, or pay the people who made the project a success ready for the next job.
- Open your business for international trade - Receivables finance works as a cornerstone for global operations.
CONS
- Fees - Like any finance product, receivables finance comes at a cost. Fees and rates should be checked thoroughly before finalising agreements.
- Not for small businesses - Many receivables finance options need your business to be of a more substantial size. It’s hard for sole traders or startups to access significant receivables-based funding.
- Possibility of over-reliance - Like many revolving credit facilities, it’s possible to lean too hard on receivables finance, locking your business into a loop where all invoices pass through the finance as a matter of course and it’s hard to break the cycle. This can lead to a long period of unnecessary fees if poorly managed.
Apply with Clifton Private Finance
At Clifton Private Finance, we’re here to help you find the perfect funding for your business; our expert business funding team are on hand to assist in obtaining the best receivables finance deals for you.
Whether it’s for invoice financing, or a large international trade deal requiring multiple levels of funding, our expertise will make sure it’s a smooth and cost-effective process.
Contact our specialist receivables finance team today.
