There are several levers that can be pulled to improve cash flow, each with their own unique benefits and drawbacks. Companies typically use AR finance to expedite payment on their receivables, providing cash to invest in business initiatives or address cash flow issues, among other things. The latter is extremely pertinent in response to the COVID-19 crisis as many CFOs and treasurers explore receivables finance as part of their liquidity management action plans.
ABL tends to be a quicker and easier option as there is no program set up. It uses a blended advance rate for the entire portfolio based on performance and, because it is a loan, counts as debt on the balance sheet.
Traditional factoring offers more flexibility than ABL due to the fact that companies can select which obligors’ accounts receivable they would like to trade. It also gives companies the option to finance their receivables from smaller or private obligors. This structure allows unsold accounts receivable to be held to maturity or monetized under other facilities such as a revolving credit agreement. However, factoring is more likely to be counted as debt. It also tends to have a higher receivables dilution and is generally more expensive because advance rates and fee structures are typically materially higher compared to other AR finance structures.
Selective receivables finance is a version of factoring, with key differences. It offers all the benefits of traditional factoring plus more competitive pricing and flexibility. Because credit risk is isolated per obligor, selective receivables finance tends to be much more cost-efficient than traditional factoring due to an overall lower risk for the funder. An additional benefit is that only the most valuable accounts receivables are sold, preventing value dilution that occurs when high value receivables are lumped together with lower value receivables. Financing rates are competitive for mid-sized companies using AR finance because creditworthiness is based in large part on the customers’ credit rating.