Receivables Financing for SME

Excerpt from Insights 2011
Receivable Financing
in the SME Space
Rajesh Gupta, Head of Product Management and Segment Solutions,
Standard Chartered Bank
FOR INFORMATION PURPOSES ONLY
With limited access to bank finance and dependence on owner capital, small and medium
sized enterprises (SMEs) are particularly vulnerable in times of low trade volumes and
limited liquidity. Accounts receivable financing is a significant source of immediate capital
for businesses, helping to ease cash flow problems. It also has many distinct advantages
for SMEs compared to traditional options.
Accounts receivable financing has its origins in the Middle Ages when it was of
enormous benefit to merchants engaging in international trade because it meant that
they were paid for their merchandise far in advance of the date when the goods were
sold to the end user, giving merchants the freedom to pay their debts to suppliers,
employees and tax authorities.
The development of accounts receivable financing was influenced by legal, technological
and communications developments and by changes to the organisational structures
of companies. By the 20th century, it began to evolve rapidly in the US, primarily in
the fast growing textile industry where it helped to accelerate growth and profitability
by improving cash flow. Long-term relationships and trust were the main basis
for these financing arrangements because there was no effective court system to
enforce international contracts for the purchase of European fabrics by American
factories.
From its humble origins, receivable financing has come a long way. It has gained
prominence and acceptance and is being offered as a valuable financial product
among major financial institutions and banks. Today, receivable financing is a significant
source of immediate capital for businesses. It is an effective solution for solving a
business’s cash flow problems and also has many distinct advantages compared to
traditional options, especially for SMEs, such as a standard business loan or a small
business line of credit. This gives businesses instant cash instead of them having to
wait to receive payment, which is why many businesses run into cash flow issues.
Receivable financing for open account credit sales traditionally is available as the
following broad variants (domestic and exports):
• Local bill discounting: This is one of the most commonly used financing tools against
receivables, especially for SMEs (including postdated cheque discounting). Banks
are comfortable discounting cheques of known counterparties and risk of repayment
is shared from a bank’s point of view. However, from the seller’s perspective, banks
still have recourse back to them, and in the case of a buyer’s failure to pay, a seller
has to take the credit loss.
• Export bill discounting: Mostly used for export sales on an open account basis.
Again, this is a wellestablished offering from many financial institutions. A company
can submit its bills for exports to banks and an upfront cash payment. Banks later
collect the payments directly from the importers.
Today, receivable financing
is a significant source
of immediate capital for
businesses.
• Invoice discounting: For both local and export sales, it is possible to get the accepted
invoices discounted upfront from the bank. This generally is more convenient for
both buyer and seller as there is little documentation required apart from a commercial
invoice accepted by the buyer confirming the date of payment. Banks sometimes
ask for assignment of receivables from the buyer. However, all of these options
have their own limitations. While open account sales are considered to be risky,
the option of getting bank finance against these open account receivables is not
risk-free either. In all the aforementioned options, the risk of non payment to banks
by buyers continues to be the greatest problem for sellers.
Current Market Scenario and the Compelling Case
for Receivable Financing
In today’s age of high credit losses and thin liquidity globally, it is impossible for
businesses to manage growth without adequate cash. While sales volumes have been
adversely impacted by lower demand, lack of liquidity has severely restricted the ability
of companies to address the challenges presented by the aforementioned factors.
SMEs are particularly affected as their sources of funding are traditionally limited to
the owner’s capital and a small amount of bank finance.
Banks have either scaled back their business and personal lending or have a very
low risk appetite for lending to new customers. At the same time, trade credit is also
scarce with suppliers keen on reducing risk and preferring cash payments even at the
cost of lower profit margins. In such straightened circumstances, businesses must
come up with creative solutions to the following issues:
• Lack of liquidity;
• Slow growth;
• Risk on credit sales;
• High cost of liquidity; and
• Low profit margins.
Accounts receivable financing may be the tool that helps companies increase capacity,
flexibility, liquidity, efficiency and sales if companies have to give credit terms to
customers and internal cash flow or bank financing will not keep up with the cash
companies need to grow.
What is Receivable Financing?
Use of letters of credit (LCs) in international trade is falling, while use of open account
and extended credit is becoming more common, helping to boost sales volumes in
an increasingly global market. Receivable financing helps to bridge the gap between
the two options by providing credit assessment, credit protection, financing and
collection services to exporters for regular sales on open account terms.
With receivable financing, a company sells its accounts receivables (invoices) to a
third party company or factor (either a bank or a factoring company), which then
assumes the credit risk of the account debtors and receives cash as the debtors
settle their accounts. As against a conventional loan, factoring is an outright sale of
the receivables in the balance sheet and helps in the maintenance of key liquidity
ratios. A typical receivable finance transaction is shown in Figure 1.
In today’s age of high credit
losses and thin liquidity
globally, it is impossible
for businesses to manage
growth without adequate
cash.
Why is it Required?
If a company cannot afford to wait to get paid by its clients, there is a solution that can
provide it with the necessary cash. With receivable financing a company can accelerate
the payment for its invoices, get funding for exponential growth and meet its recurring
obligations.
There are many advantages to receivable financing for a business. Invoices will be
processed by the bank/factor. It also offers increased flexibility to extend terms to
customers, which can translate into more sales and conversions. This can be achieved
without harming cash flow. The advantages are as follows:
• Payment discounts: Receivable financing may very well allow a company to take
advantage of early payment terms offered by its suppliers. By enhancing cash flow
through consumer receivable financing, a company may be able to save, say 2%
of its raw materials cost because it will have the cash to pay bills within 10 days.
This in turn can reduce financing costs.
• Volume discounts: Another advantage to a company of financing its retail
instalment contracts is that it will be able to buy in greater volume from its suppliers
because of its improved cash flow position. By ‘cashing out’ its retail instalment
contracts within days after the contracts are written, rather than waiting one, two
or even three months or more to be paid, a company will be able to experience first
hand the ‘time value of money’. Thus, it will be able to take advantage of volume
discounts offered by its suppliers.
• Equity: By factoring consumer notes to provide capital needed for growth, a company
will not be giving up any equity. Many companies find themselves looking for venture
capital, sometimes because they think this is the best or only option they have.
However, while venture capital certainly has its advantages, with venture capital
a company will have to give up equity, as well as take on unwanted partners.
• Debt: When a company factors consumer contracts (consumer receivables, retail
instalment contracts or consumer notes) it does not incur debt because factoring
is not a loan. This keeps the balance sheet clean, and thereby puts the company
in a more favourable position than it would otherwise be in, should it opt to apply
for a loan or line of credit in the future. Likewise, should the owner(s) ultimately
decide to sell the company, the balance sheet would not reflect debt since, once
again, factoring does not involve a loan.
• Building credit: Once a company begins financing its consumer receivables, its
cash flow will improve. This will enable the firm to begin to pay its bills on time, and
this in turn will position it to establish and/ or improve its credit. The logic of this
process would be to improve the company’s chances of getting credit terms from
suppliers, as well as improving its ability to acquire conventional financing in the
future.
Another advantage of accounts receivable financing is that it is like a line of credit that
increases as a business grows. There are commercial finance companies
that provide accounts receivable financing for small, medium and large businesses.
As a tool, accounts receivable financing allows companies to tap into the power of
their greatest assets – the credit of their creditworthy customers and their obligation
to pay for goods and services companies have sold to them. It allows firms to take
advantage of new opportunities and grow exponentially.
With receivable financing a
company can accelerate the
payment for its invoices, get
funding for exponential growth
and meet its recurring
obligations.
S
e
p
t

2
0
1
1
Rajesh Gupta
Rajesh Gupta has over 17 years of corporate banking experience with Standard
Chartered Bank and ABN Amro Bank in India, the Middle East and Europe. He has
worked in relationship management, transaction banking and in the SME segment.
In his present role, Mr Gupta is responsible for product and segment development
within SME. In the past, he was the business head for the Medium Enterprise Client
segment, wherein he also oversaw a dedicated unit focusing on developing the Middle
East-Asia trade corridor by leveraging Standard Chartered’s strong network in those
regions. Mr Gupta is a chartered accountant and holds a specialised certification
in International Cash Management from the Association of Corporate Treasurers, UK.
This communication is issued by SC Group. While all reasonable care has been taken in preparing this communication, no responsibility or liability is accepted for any errors of fact,
omission or for any opinion expressed herein. You are advised to exercise your own independent judgment (with the advice of your professional advisers as necessary) with respect
to the risks and consequences of any matter contained herein. SC Group expressly disclaims any liability and responsibility for any losses arising from any uses to which this
communication is put and for any errors or omissions in this communication. “SC Group” means Standard Chartered Bank and each of its holding companies, subsidiaries, related
corporations, affiliates, representative and branch offices in any jurisdiction.
© Copyright 2010 Standard Chartered Bank. All rights reserved. All copyrights subsisting and arising out of these materials belong to Standard Chartered Bank and may not be
reproduced, distributed, amended, modified, adapted, transmitted in any form, or translated in any way without the prior written consent of Standard Chartered Bank.
Here for good
standardchartered.com