The World Trade Organisation estimates that the ‘vast majority’ of the US $23 trillion in annual global trade relies on some sort of financing or guarantee between buyer and supplier. For suppliers of export goods, trade financing encompasses a range of services: bank working capital loans and letters of credit; invoice financing, which involves either advances against accounts receivable or outright selling of invoices to a financing company (factoring); or even payment guarantees such as credit insurance.
Even though there’s a high demand for trade financing, it’s not always available to medium and small exporters. The Asian Development Bank calculates the unmet demand for trade financing to be US$ 1.5 trillion globally, with exporters in Asia feeling the most acute need for solutions to solve their working capital crunches.
This article looks at one of the most straightforward trade financing methods available for exporters – accounts receivable factoring. This form of financing solves a classic dilemma in international trade. A supplier wants to get paid at the time the goods are shipped, while the buyer prefers open account payment terms that leave time for receipt, distribution, and sale of the goods. This time lag prompts the need for credit facilities of up to 120 days, which is a market of over US$ 10 trillion annually according to the Bank for International Settlements.
In a typical invoice financing transaction, the supplier sells invoices to a finance company at a discount at the time of shipment of goods. The supplier receives payment upfront and, in cases of non-recourse factoring, payment is guaranteed because the risk of buyer non-payment due to bankruptcy is transferred to the financing company.
Invoice financing is a standard solution for domestic trade in many countries and is gaining more attention in cross-border trade. Figures from FCI, the largest industry group for the open account receivables finance industry, show that international factoring volumes grew 30% from 2011 to 2018. One reason for the growth trend is that invoice financing is a quick and straightforward solution to implement, and can be used in conjunction with bank loans. It is also flexible, allowing the supplier to control the injection of working capital by choosing when and which invoices to sell.
Ideal situations for export receivables financing
While many companies rely on invoice financing for their everyday working capital needs, three instances stand out as especially conducive to this form of trade liquidity.
1. Rapid growth
Fast-growing companies often have capital needs that surpass their bank lines of credit or loans. For these firms, accounts receivable are an asset that can be quickly converted to cash with no impact on the bank relationship. Invoice financing is the most straightforward way to get supplemental financing to accept and fill more orders.
This is especially true for companies operating in sectors with high seasonal needs like apparel and holiday products. Seasonality can cause large fluctuations in a company’s cash flow, inventory and profitability, distorting the financial ratios that banks use to make lending decisions. Invoice financing provides supplemental working capital during these peak times.
2. Turnaround situations
Businesses in “turnaround” are returning to growth after a period of poor performance caused by an external shock such as recession or internal restructuring of finances or management. Firms in turnaround find themselves at an impasse: even though prospects are good, the company’s financials might not merit a full bank loan program. But financing is often needed to take advantage of growth opportunities.
Receivables financing can be a lifeline for companies in this pickle. This is possible because in invoice financing, the finance company bases its credit decision of the financial health of the buyer, not the exporter.
3. Trade to countries outside of bank jurisdiction
Since the 2008 financial crisis, banks have been stepping back from cross-border trade activities. Regulatory constraints have grown, the paperwork burden is costly and cuts into profits, and geopolitical risks have become more volatile.
This environment gave rise to the $1.5 trillion trade finance gap, which has acutely impacted firms in the middle market. These companies turn to invoice financing when their bank cannot support sales to a particular jurisdiction. Non-bank players like Stenn are able to step in and offer options to companies left behind by banks.
Receivables financing has found its place as a viable option for exporters of goods. With no long-term contracts and no requirement to factor all invoices, factoring because another option in the working capital toolbox, alongside services from traditional banks.