Pluses and Minuses of Receivable Finance

Receivable finance is a novel and non-conventional way of converting credit sales into cash. In USA it is known as receivable finance and in the British Commonwealth as factoring. The system basically collateralizes your credit invoices. Financial institutions dealing in commercial credit are front runners in this mode of activity. Let see what it can do for you:

How it works

You sign up with a financier an agreement to finance your trade receivables. Once a credit sale is made you generate a trade invoice, deliver the goods/service to the buyer and send the invoice to the financier after receiving the acceptance to, by the buyer who signs over the face of the invoice. It is concomitant on the seller that he deals with credit worthy buyers. These invoices are verified by the financier who will do a check on the credit worthiness of the buyer and discount the bill according to the agreed rate of interest and the net amount is credited to your account. Receivable finance takes various forms:

1) Recourse Finance: Under this method you are liable to pay the financier in case the buyer does not meet his obligations on due date

2) Non-recourse Finance: In this case any buyer default is absorbed by the financier who takes adequate payment insurance to cover any perceived default

3) Processing Debt Collection: In most cases financiers would undertake processing of the debt collection including recording debt, collecting payment, depositing cheques, generating reports, chasing debtors and do other follow-up activities. Some banks grant receivable finance without undertaking collection on their part

4) Quantum of Finance: Generally financiers grant full quantum of the invoiced value less the discounting charge which is pegged onto monthly interest rates. Banks such as HSBC use a method where they extend portion of the invoice value upfront and the balance after the buyers pay up less any discounting charge

5) Selective Debtors: Under this scheme the financier has the right to choose which invoices he will finance and which he will reject.

Pluses

1. Receivable finance converts paper into money; debtors into capital; sales into cash-flow. You get your credit sales as up-front cash, improving your business sales and prospects

2. This is more flexible arrangement than bank loans or bank overdraft/line of credit. You have no hassle in submitting financials, tax returns and various other statements that are called for in processing conventional finance applications. Moreover, there is no limit imposed by the financier on the amount you can raise

3. Under no-recourse finance you have no responsibility for the eventual payment by the buyer

4. Where processing debtors is on the part of financier you are relieved of all the paper work and trouble in going behind debtors

5. You can deal in open account by enlarging your business operations; advance payment and letter of credit or accommodation are no longer necessary

6. Most important, you have cash resource to make your purchases without credit terms; this helps in negotiating for concessionary prices and favourable terms of delivery from your creditors who supply you materials and services.

Minuses

1. Before you sign up on the dotted line of the Receivable Finance Agreement, you must read and understand what it tells about your responsibility, your liability; the way you will get your finance etc. You should distinguish between recourse and non-recourse methods; on quantum of finance, selection of debtors and collection of receivables by the financier. If you do not understand the receivable finance methodology you will regret later

2. You must first ask the question. Do I really need this money from the financier? Can you employ the cash-resources on useful matters or will it simply idle in a checking account

3. Cost of receivable finance is very prohibitive compared to conventional bank loans. Discount rates currently hover between 0.75 to 1.50 % for a 30 day period. When annualized it goes as high as 9 to 18%. Can you afford this cost?

4. Receivable finance is suitable for a business that is in start-up or in first level growth stages when they are cut away from conventional banks. Once a business moves into secondary level or growth area they have enough credentials and clout to negotiate with bankers who can offer more completive schemes in financing working capital

5. Receivable finance has worked successfully in few sectors such as health care services which are covered by national health schemes or corporate re-imbursement schemes. I have seen receivable finance doing excellently well in advertisement industry. But in many other industrial or commercial sectors it could be a big flop

6. Cosmics play havoc when you get into receivable finance. Many customers feel second rated when someone else other than the seller contacts them for payment or follow-up. Later they do not turn up to buy anymore. The troubling phenomenon is that receivable financing conveys to many that the seller is going through financial woes. Your initial euphoria of getting cash promptly evaporates afterwards when you see your customers turning their backs on you. You are aware cosmics are aspects that are within you shaping and influencing your business throughout. Weigh your cosmics and your need to go for receivable finance and make a trade-off.

Muthu Ashraff

Cosmic Adviser

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E-mail : cosmicgems@gmail.com

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