Also known as receivables finance, accounts receivable (AR) finance allows companies to receive early payment on their outstanding invoices. This financing can be structured in a number of ways but generally involves a company selling their invoices, minus a financing fee, prior to its customer paying the invoice, thus securing early payment and improving cash flow. This is done without involvement from and, in the right circumstances, disclosure to their customers, also referred to as obligors or buyers.

There are several options for financing accounts receivable, three of which are explained below: asset-based lending (ABL), traditional factoring and selective receivables finance. Asset-based lending (ABL) is a loan using assets (like accounts receivable) as collateral. ABL takes an all-or-nothing approach that requires companies to finance all of their accounts receivable. Traditional factoring is when a company sells receivables to a third party for the invoice value minus various fees and reserves. Unlike ABL, factoring allows companies to choose receivables from specific obligors to sell, however all receivables from that particular obligor must be sold for early payment. The third option is selective receivables finance, which allows companies to get paid early on specific invoices for their largest customers depending on their cash flow needs. Companies can select specific obligors from whom they would like to sell accounts receivables for early payment. Companies using this structure also have the added flexibility to choose which receivables of those particular obligors they would like to sell for early payment. The only conditions for selective receivables finance are that the obligor must be a financially well-positioned, public company and the total accounts receivable with that obligor must typically meet a certain threshold (although this varies based on the funder).

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.

Dilution is the difference between the face amount of invoice(s), also known as gross value, and the payment typically collected from the customer(s). Reasons for receivables dilution can include write-offs, returned goods, credits and more. Thus, dilution rate (the percentage that dilution represents over the gross value of invoices) is a key metric utilized by funders to assess risk associated with paying early for receivables from a specific obligor or buyer.

There are three main factors funders look at to asses suitability for a receivables finance program: Obligor risk is one consideration for funders when assessing a program. Funders examine each obligors’ characteristics, quality and risk profiles. Funders also assess the total value of receivables. Many funders require companies to reach a certain threshold of invoice value per obligor. If the receivables are too small, the company will likely not be eligible. Lastly, funders examine the seller’s credit profile, financial performance and short-term risk of the company’s industry.

Many companies have pledged their receivables for various reasons, but there are measures that can be put in place to implement successful receivables programs

Selective accounts receivable financing is a true sale of receivables. Unlike other AR finance structures such as ABL, selective receivables finance is not a loan and does not count as debt on the balance sheet.

SCiCustomer is PrimeRevenue’s cloud-enabled selective receivables finance solution that enables companies to sell their receivables from selected customers to a third-party financial institution for early payment. Some common features of a SCiCustomer selective receivables program are: Trades are considered “true sale” Programs can be complex in nature, spanning multiple seller entities, obligors and currencies PrimeRevenue provides a funding marketplace to source appropriate liquidty Traditional bank-led receivables finance programs are typically validated manually and executed with spreadsheets over email. SCiCustomer automates the validation process, provides visibility into all historical invoice data, reduces errors in rate calculations, and provides reporting capabilities and email notifications on program activity.