Evolving beyond financial management to acting as an advisor to business units, corporate treasurers play a catalysts’ role in helping corporations to expand and globalize. Receivables financing is but one tool in the treasurer’s toolbox that can support business growth.
Priorities of treasury today
With globalisation of trade, goods and information are moving even faster through the supply chain network involving more players in more locations than we have seen in the past. As corporations expand into new markets, the need for balance sheet management and access to liquidity, optimising working capital and risk management, are increasingly becoming top priorities for treasury. By taking a more holistic approach towards managing receivables, treasurers not only achieve these objectives but also gain control over their cash.
A means to an end: supporting the financial strategy
Receivables financing is one such tool increasingly deployed by treasurers that bundles solutions to all of the above requirements, helping corporations achieve their business objectives. Improving the cash conversion cycle is not limited to managing liquidity for a corporation and accelerating the cash conversion cycle could lead to significant improvement in returns on invested capital. Converting receivables into cash, and ensuring that this also results in reducing the day sales outstanding (DSO), means there is more available cash to release working capital trapped in trade receivables and creates additional capacity within the business to self-fund business growth.
A receivables financing solution, structured properly, provides a true-sale funding of receivables without utilising the amount of existing bank lines or increasing other forms of debt. With the costs associated with receivables financing significantly less in most cases than the cost of capital, receivables financing provides an attractive alternative source of funding which optimises the balance sheet by converting receivables assets into cash assets via a receivables sales structure.
Inherent in a receivables financing structure is the transfer of specific credit and payment risks to the financing bank. As a business expands into new markets, new geographies and enters new client segments, corporates need cover to manage counterparty and cross-border payment risks. One of the biggest hurdles companies face is how much credit they can continue to give to their buyers.
Traditionally customers have used credit insurance to cover such risks while keeping receivables on the balance sheet using internal and external funding sources. However, with increased focus on achieving financial efficiency and requirements to keep exposures within internal risk guidelines, treasurers are increasingly looking out for comprehensive solutions that not only provide liquidity, but also offload counterparty, and where relevant, foreign currency payment risks. A well packaged receivables financing solution protects the seller from buyer insolvency and foreign exchange payment risks.
Customised to meet requirements
Receivables financing solutions can take the form of bespoke solutions covering specific counterparties, or a portfolio based approach covering an entire pool of receivables from multiple counterparties with different size and risk characteristics. Success lies in the solution’s fit, ease of implementation and continued availability – with certain conditions precedent of course Large-sized bespoke solutions are generally driven by the need for mitigating counterparty concentration risks, optimising the balance sheet through lower DSOs together with providing an ongoing source of liquidity. Receivables financing strikes the optimal balance between retaining competitive edge and financial discipline. But when it comes to cross-border trade receivables, additional challenges arise due to multiple legal jurisdictions governing buyers and sellers and impact the perfection of receivables sales and transferability of the titles. A global banking partner with a large international network, client relationships, knowledge of local regulations and tried and tested documentation can help large corporations in implementing receivables financing programs across a wide range of buyers and sellers in varying jurisdictions.
A good illustration of such a true-sale solution is a set of programmes put in place for a large Korean OEM for its sales of key components to global brands. Citi established a global receivables financing programme, covering counterparties in Europe, the USA and Asian countries like Japan and Taiwan, which has enabled this company to monetise large value, high quality investment grade receivables through a single window at an attractive price while embedding all the necessary elements of true-sale.
Many large corporations expect their service providers to provide comprehensive receivables financing solutions across their entire portfolio. Credit insurance has been widely used by corporations to cover entire receivables portfolios and insured receivables are then monetised by financial institutions.
Credit insurance however is not the panacea, as coverage may be limited in many markets and where existing, these policies come with onerous conditions related to risk management practices and pre-requisites for honoring a claim in case of a payment default. This is leading to some innovative approaches to receivables financing by way of risk sharing between the seller and the bank. Under risk sharing, the customer agrees to underwrite a first or second loss on the portfolio, such proportion being determined on historical performance of the portfolio and risk profile of the counterparties. Such solutions become more holistic presenting completeness of counterparty coverage and workability across multiple jurisdictions. Another important but understated benefit is improved risk management as there now exists another set of eyes (as in the bank) which keep a close watch on portfolio performance.
Extending the portfolio approach to traditional distribution financing
Emerging markets in Asia provide the most attractivegrowth prospects for multinational corporations where a wholesale distributor network or medium size enterprise system is often used to reach different geographies. To help these sellers expand sales, some banks offer channel financing, a direct lending solution based on the credit history and length of the relationship of the seller and the buyer. Unfortunately the success of this approach remains less than desired, as banks in most cases are unable to provide a solution that covers the entire spectrum.
At its most basic level, a distribution finance programme enables a seller of goods to extend payment terms for its recurring customers. This improves a buyers’ working capital position, an improvement that is tied to incremental purchases of the seller’s products. Sellers perceive buyer financing as an essential element for seeking incremental sales opportunities and hence are willing to consider alternatives to address this gap. Citi’s distribution financing creates an altogether different type of structure that extends payment terms for the distributor through a risk sharing partnership with the seller. Risk sharing could take the form of first loss or second loss being absorbed by the seller with the bank taking the rest. The solution encompasses commercial realities to ensure participant commitment and provides choices to the counterparties.
It’s a win-win solution for all parties involved: sellers are able to leverage their balance sheet toward their sales goals, and for the distributor, this solution provides access to a new source of funding at competitive pricing.
Receivables at a complex space
While many financial institutions can offer ‘borrowing base’ working capital solutions, only a handful, like Citi, bring the rich experience of providing comprehensive solutions that deliver multiple benefits. Receivables financing can assist corporations in achieving working capital efficiency and realise new revenue potential in line with their growth objectives.
It remains a powerful tool for optimising liquidity in industries with complex global supply chain operations and distribution networks, where typically receivables financing has the largest potential for working capital savings.
Structuring a receivables financing solution requires an in-depth understanding of commercial terms, legal jurisdictions in which the buyers and sellers operate and governing laws applicable to the commercial contracts. Receivables financing is a highly customized solution, and while the framework may be the same, every program must be tailored to the needs of each business. A relationship with a global bank is key to a successful receivables financing programme. Citi’s global footprint and intellectual capital built through the execution of a significant number of deals in multiple markets can assist corporates in assessing the risks and development of a solution which best fits their needs. ��