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What is receivables finance?

Receivables finance, or receivables financing, is a trade finance method businesses can use to receive funding matching the amounts owed to it by its customers in outstanding invoices. These amounts are known as trade receivables or accounts receivable. By financing its receivables, a business can receive payments earlier, meaning it can invest in business growth and innovation.

Receivables finance is also known as accounts receivable financing. A business using accounts receivable financing sells some, or all, of its outstanding invoices to a third party known as the funder or financer.

This effectively means they receive early payment on those invoices. Although some methods incur a fee, receivables financing can give businesses a working capital boost that they can use to fuel growth.

Types of receivables finance

There are several different types of receivables financing options open to businesses, including:

  • Factoring: Factoring is a financing method that involves a company selling its receivables to a third party, known as the factor. Typically, the company will receive between 70% and 90% of the value of the chosen receivables from the factor to begin with. The factor will then collect payment from the company’s customers at maturity and will send the company the remaining payment (minus a fee). Factoring is not to be confused with reverse factoring or supply chain finance, in which the buyer initiates an early payment program for its suppliers.
  • Invoice discounting: Invoice discounting is a similar technique to factoring, with the main difference being that the company remains responsible for chasing up payment from customers As such, invoice discounting tends to take place confidentially, with the company’s customers not necessarily being aware that invoice discounting is being used.
  • Asset-based lending: Whereas invoice factoring involves the sale of receivables, asset-based lending (ABL) enables companies to secure loans based on assets such as accounts receivable. ABL can also be secured by using other assets as collateral, such as inventory or equipment.

The term ‘accounts receivable financing’, or ‘AR financing’, is also sometimes used, although this means different things to different people. In some cases, accounts receivable financing is used as a synonym for receivables financing. Others may use it as another term for factoring, or to describe a type of asset-based lending.

How receivables finance works

When companies sell goods or services to their customers, they often do so by extending credit, meaning that their customers do not need to pay until a date in the future. This benefits the customer, but for suppliers that are not cash rich, this type of arrangement can cause cash flow issues that make it difficult to fulfill customer orders or invest in business growth in the immediate term.

Receivables finance can enable companies to overcome this shortfall. By enabling early payment of invoices before their due date, companies utilizing receivables finance can reduce the delay between purchasing raw materials and receiving payment from customers. They may also be better placed to invest in R&D, innovation and expansion.

Choosing the right arrangement

Firstly, there are a number of considerations to think about when it comes to choosing the right receivables finance arrangement for a particular company’s needs. The company will need to consider various questions, including:

  • Recourse or non-recourse? Receivables financing techniques like factoring may take place on a recourse or non-recourse basis. In a non-recourse arrangement, the financer takes on most of the risk if the company’s customers fail to pay their invoices. If the arrangement is on a recourse basis, the company will remain responsible for any issues with non-payment.
  • Sale of receivables or loan? An important distinction where receivables finance is concerned is whether an arrangement constitutes a true sale of receivables to a financier, or a loan which is secured against the company’s receivables.
  • Confidential or disclosed arrangement? If a facility is confidential, the company’s customers will not be made aware of the arrangement. If it is non-confidential or disclosed, customers will be informed that financing is taking place. Some companies won’t want their customers to be aware that they are carrying out receivables financing, which may affect the type of arrangement chosen.

Receivables finance process

To take factoring as an example, the receivables finance process may go like this:

  • Seller sells goods to buyer
  • Seller issues an invoice to the buyer
  • Seller sells the invoice to the factor
  • Factor pays seller a cash advance of 70%-90% of the value of the invoice
  • Buyer pays the invoice
  • Factor sends the balance to the seller with fees deducted.

Buyer-initiated programs

While receivables financing structures like factoring are initiated by the company selling goods, buyers can also put in place structures that enable their suppliers to finance their receivables.

For example, a company can adopt a supply chain finance program (also known as reverse factoring). In this case, the buyer enables suppliers to access early payment from a bank or other finance provider, with the cost of funding based on the buyer’s credit rating instead of the supplier’s. This type of solution can unlock working capital for both the buyer and supplier while strengthening supplier relationships.

Dynamic discounting is another form of early payment program that is initiated by the buyer. Instead of asking a finance provider to pay invoices early, the company uses its own surplus cash to fund the program by offering suppliers the opportunity to take early payment in return for a discount. In this way, the buyer can earn a risk-free return on their own cash, while giving suppliers access to affordable financing.

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