Choosing between working capital funding solutions? We look at the alternative finance model of Receivables Trading and the traditional Invoice Discounting option. Both are used to address working capital requirements. However, as you will see they work and benefit the SME in very different ways.
Firstly, let’s define each.
What is Receivables Trading?
Receivables Trading is an alternative finance solution. It works on the principle that companies can leverage their high-quality Receivables as a tradable assets. Where your customers are multi-national companies or state agencies, your Receivables are considered to be of high-quality. You can trade your customer Invoices (“Receivables”), Purchase Orders/Approved Contracts or Future Recurring Revenue (“Future Receivables”) to access unrestricted funding directly from a pool of Institutional funders managing liquidity from insurance companies, pension funds, professional investors and even banks.
It operates on an online platform and is very flexible. For example, not only can you sell 90% of an approved invoice and access cash in 24 hours you can also access finance on the back of the Purchase Order or Approved Contract. The cashflow released is used to fulfil the contract and pay suppliers upfront. In addition, as it’s the sale of an asset, and not the extension of credit, funding is not limited by Debtor Concentration, geography (country of export) or transaction risk (size of the order). These innovative features are unique to Receivables Trading.
What is Invoice Discounting?
Invoice discounting is essentially a form of short-term financing against your outstanding invoices. The Provider takes a legal charge over your entire Debtor book. This is the case regardless of which Debtors you want to discount and the percentage advance you get depends on the concentration of each Debtor in the overall ledger. It is traditionally used to help improve a company’s cash flow position. With invoice discounting, you maintain responsibility for the management of your Debtor book in terms of invoicing and debt collection.
The 5 key differences
While you maintain and manage your customer relationships, the Provider ultimately controls the % you can get upfront hinging on a number of moving parts that cannot be estimated in advance – no real certainty at any one point in time.
Receivables Trading is completely different. There is no charge taken nor is there any interference with your customer. In fact, you can control and select which Debtors you wish to trade to optimise the gaps in your working capital. It’s no problem if you already have an ID facility – all you need to do it get a specific Debtor carved out from the Facility then those receivables are free to trade.
2 Certainty of Funding
With Invoice discounting any changes in your Debtor book may result in a level of debt being disallowed. As such, while you agree a facility limit at the outset of let’s say a 24month commitment, the actual funding available can vary significantly. For example, if Debtor Concentration is a concern, only €1.4m may be allowed on a €3m facility. This level of volatility can be difficult to manage and can act as a major dampener to business growth. Think about it, would you readily tender for more business while unsure of how to finance it?
In contrast, Receivables Trading is 100% reliable. You decide which Receivables you want to trade and you know exactly how much will be released from the invoice or Purchase Order. In addition, funds will be in your account within 24 hours of uploading the Receivable.
3 Limits and Cost
Various limits and costs are attached to Invoice Discounting. This is a facility which means that aggregate limits apply, namely the facility limit itself. However, as described above, Debtor Concentration and geography limits can significantly alter your available funds at any one time. For exporters, funding can be limited due to the perceived risk attached to the country of export. This can be restrict your opportunity to tender for global business.
In terms of costs, there are fixed overheads – monthly fees, audit fees and transaction fees. Credit Insurance, Foreign Exchange and Exit Fees are often standard. The facility is usually agreed for a 12-24month duration. Any break in this agreement can result in Exit Fees being applied.
In total contrast, Receivables Trading costs are simple with no hidden or lock-in fees. This is a ‘Pay as you Go’ model where the only cost is the cost of finance per transaction.
4 Which business type
Typically, any business obliged to wait 30 to 120 days for payment has a need to proactively manage their working capital – regardless of sector. While Invoice Discounting can be employed for all debtors, Receivables Trading is ideally suited to SME’s with blue-chip customers. Also, companies with monthly recurring revenue.
While Invoice Discounting works, it only applies when you have raised the invoice for completed work. In addition to unrestricted invoice trading Receivables Trading has a solution for:
Companies that need finance earlier (Purchase Order Finance)
You can access finance as soon as the contract with your customer is signed. This is called Purchase Order Finance. The majority of businesses don’t even realise this is an option in the Irish and UK markets. The Sales Purchase Order or Approved Contract is traded to release the cashflow required to fulfil the contract and pay suppliers upfront.
Companies with subscription income (Future Recurring Revenue)
SME’s with subscription income such as SaaS licence fees, can also benefit. This income is known as Future Recurring Revenue and is considered an ‘asset’ in Receivables Trading. This is not the case in traditional finance solutions. Companies can leverage their future recurring revenue to release cashflow 3 months in advance. Companies use this cashflow to pay suppliers upfront, fund expansion, equipment or technology development. It is a progressive source of finance for technology and hospitality companies with subscription income.
So, which option is right for your business?
Naturally, it depends on your business model, growth plans and working capital requirements.
Invoice discounting is a common feature of business as for years, it was the only dedicated working capital funding option available. While it continues to play a role in the market, the pace of change in business exposes significant weaknesses.
Receivables Trading fills this gap. It centers on a market-based funding solution that is economically accessible to SME’s, using technology to connect them with a pool of institutional funders seeking trade receivables as an investment asset class. SME’s with high-quality Receivables can easily access this marketplace, particularly companies facing restrictions based on concentration or geographic limits.
Receivables Trading is an incredibly effective way for SME’s to fund their business for transformational growth.