Domestic accounts receivable finance, or invoice factoring, is commonplace around the world. Companies turn their accounts receivable into ready cash at the time of invoicing by selling them to a finance company, rather than waiting 30 to 60 days or even longer for payment. This gives companies working capital to pay their vendors and employees. It works especially well for fast-growing enterprises that need funds to expand.
The picture changes for export trade. Banks and traditional finance companies are reluctant to lend against export accounts receivable – the risk factors are too many. Traditionally, other methods, like bank letters of credit and credit insurance, have been relied upon to mitigate risk in export trade.
But as global trade volumes have grown, the high cost of compliance has caused banks to step back from their international activities and technology has fuelled the rise of fintechs, new options for cross-border receivables finance have emerged.
This development is great if companies have new options for working capital relief. However, the changing market landscape is not well understood. Here are the five most common misconceptions about export receivables financing.
Banks and factoring companies typically shy away from export receivables due to the added risk. These factors include currency exchange risk, collecting debts abroad, geopolitical risk, and the difficulty assessing creditworthiness of international companies.
But there are specialist companies, Stenn included, that make it their business to overcome the hurdles in financing cross-border trade. Alternative finance providers and fintechs are getting involved to pick up the business that banks don’t want or can’t profit from, namely SME and mid-market exporters. Export Credit Agencies (ECAs) in many countries also support exporters with programmes for trade guarantees and financing.
International trade financing has long relied on ‘tried and true’ methods, including letters of credit and credit insurance.
Letters of credit – This is an instrument issued from your buyer’s bank stating that the buyer has reserved funds to pay the invoice. Letters of credit used to be the chief form of payment guarantee in global trade but are used less and less because they are cumbersome and tie up the buyer’s credit line.
Credit insurance – This is an insurance policy that indemnifies you in case your customer doesn’t pay or goes bankrupt. Credit insurance is a useful solution for companies that need credit risk control without financing. However, the process can be paperwork-intensive, wait times for claim payments can be long and insurers typically only protect 80-90% of the invoice amount, so you are on the hook for the remainder.
With the advent of technology to support the intensive back-office work that international trade requires for checking credit and confirming documents to prevent fraud, new trade finance solutions have appeared. There are now more choices, but exporters need to look carefully to determine what services are being offered. For example, fintech marketplaces offer receivables purchase, where financiers ‘bid’ on receivables uploaded by exporters. The concept is great, but exporters face the uncertainty of not knowing if their receivable will be purchased and at what terms – not exactly a great way to forecast cash flow.
When searching for a provider, here are some things to look for:
Is it a stable company that’s financially solid and backed by strong investors?
Does it operate in the countries where you trade?
What is it really offering? Are your receivables being purchased, or simply used as security for a loan? How much of the invoice amount is being advanced? Are there any hidden fees or recourse in case your buyer doesn’t settle the invoice?
A bit of research will help you find a provider that meets your needs.
It doesn’t have to be. In a typical export receivables finance transaction, the finance company will purchase an exporter’s accounts receivable at the time of shipment of goods. The financier will advance 80-100% of the invoice value, less any fees. The buyer then pays the financing company at the invoice due date.
Here’s a look behind the scenes: The finance company evaluates the creditworthiness of the exporter’s customers (the buyers) and grants a credit limit amount and financing rate for each buyer. At the time of shipment, the exporter provides the invoice and supporting documentation to the finance company for review. After the finance company confirms the transaction, and the buyer agrees to remit payment to the financing company, the exporter is paid the invoice amount less the financing fee.
This process can work alongside any arrangements established with a lender. There is no impact on existing lines of credit or other loans, and no security is required.
In the case of non-recourse financing, once the invoice is sold to the finance company, the finance company takes on the risk of non-payment from the buyer. This guarantee is one reason fast-growing exporters find exporting financing especially attractive.
The financing company doesn’t get involved in negotiations or exchanges between the exporter and the import buyer. The only thing the buyer will need to agree is to pay the financing company at due date, instead of the exporter. In some cases, arrangements can be made so that payment is made to a third-party lock box account should the buyer wish.
The actual cost depends on the payment terms of the invoice(s), the volume you wish to finance and the creditworthiness of your buyer(s).
When comparing rates with other solutions, be careful to do an apples-to-apples comparison. Other methods, like credit insurance, only offer protection. And letters of credit guarantee payment but require some work, expense and commitment of credit line from the buyer. Depending on the provider, export receivables financing can be a comprehensive package that combines upfront payment with risk mitigation and collection. Looking at the bigger picture puts the cost comparison into perspective.
An exporter’s business needs come into play as well. During times of expansion or peak season, having the flexibility of a solution like export receivables financing can solve working capital problems at management’s discretion, since committing the whole portfolio of business is not required.
All of this is a welcome progression for a financing tool that previously stopped at the border. The rise in new options for export trade financing means more flexibility for exporters to augment their working capital in global supply chains – if they’re able to get past the myths.