Receivables Finance refers to several options a company has to raise funds against invoices that have been generated but not paid. The notion of ‘receivables’ refers to unpaid invoices. The options in receivables finance revolve around using these unpaid invoices to generate cash for a company. This liberated cash can be used to strengthen working capital as well as make improvements to a company.
Receivables is often referred to as ‘trade receivables’ and ‘accounts receivable’.
Receivables Finance
There are 3 main types of receivables finance available to a company:
- Factoring. This is when a company takes an unpaid invoice to a factoring company. The factoring company confirms the legitimacy of the invoice. If the factoring company is satisfied the invoice is genuine, it will enter into an agreement with the company whereby they will pay 70-90% of the face value of the invoice within a couple of days. The factoring company will wait to take payment from the debtor. Once the debt has been paid, the factoring company deducts its fee and remits the remaining money to the company that used its services.
- Invoice Discounting. This is similar to factoring. With invoice discounting a third party accepts an unpaid invoice as grounds to release 70-90% of the invoice value to the company awaiting payment. The main difference with factoring is that it remains the responsibility of the company to chase up clients for payment. Invoice discounting is often done without the knowledge of clients.
- Asset-based lending. This is when a company can use a third party to release the funds early but secured against collateral. This collateral could be inventory, equipment, commercial property or accounts receivable.
More Considerations
Receivables financing offers several options. It is up to a company using its receivables to secure early payment of invoices to pick carefully. Here are some of the salient considerations:
- Recourse or non-recourse? ‘Recourse’ is a legal term meaning there is a legal and enforceable right of compensation. In recourse factoring the factoring company does not take responsibility for paying the amount due if the debtor defaults, goes bankrupt etc. A company using recourse factoring should choose carefully which invoices to use in this type of receivables finance. The opposite is the case with non-recourse factoring. In this scenario the factoring firm accepts the invoice at a discount price and it is the factoring firm’s responsibility to collect on the due date for the invoice. For this reason, non-recourse factoring incurs higher fees.
- Sale or Loan? A company must decide whether they are selling receivables to a financier to access early payment, or whether the receivables are kept but used as security on a loan.
- Who chases up the money? Receivables finance often allows for discretion on who the debtor communicates with regarding late payment. Clients can often take umbrage at being hounded by a third party for payment. However, factoring firms often have experience and a dedicated legal team to make sure the original invoice is paid in full.
In Summary
Receivables refers to invoices for sales made that have not been paid for. A company can use these receivables to secure early payment via a third party, usually a factoring company. When structuring receivables finance it is important for a company to make sure they are deploying the best options.
