Invoice factoring has been going on in various forms since Mesopotamian times.
- Banks “buy” customer invoices at a discount from a supplier.
- In return the supplier gets the majority of the cash value of the invoice upfront.
Factoring was a predominate form of financing in the United States textile industry right up to the early twentieth century due to the lack of large banks that could provide loans large enough to support large companies operations. These days, factoring solutions are offered by banks in many countries mainly focused on smaller businesses.
In the last 10 years there has been a revolution in invoice discounting due to the establishment of web based companies that are capable of interacting with far more customers than old fashioned factoring and have the willingness to reach out to much smaller companies that the traditional factoring regimes may have overlooked. The result is that in Europe and North America it easier than ever to avail of these services. Again these services tend to be focused on smaller businesses and it has been shown that factoring can be a very expensive form of credit unless your customer base is full of blue chip customers based in countries with good credit ratings. For this reason factoring has become very much a minority activity in business, although it still has its place as a very firm niche.
One of the developments of recent years is the emergence of receivables exchanges. There is one side to these businesses, that is an exact replica of traditional factoring, except that it is not banks who are “buying” the invoices, but various types of financial institutions and even some larger companies with surplus short term cash reserves.
The supplier business can potentially sell their invoices at lower discount than they would have received from the bank and the buyers can earn a modest amount on cash that otherwise would have earned them almost nothing in a traditional bank account. To succeed these exchanges depend on a constant stream of cheap liquidity coming from the buyers. When it works, it can be a win-win scenario for all the players. So far this idea has made some headway in the United States and is only starting in Europe.
“Buying” high quality invoices
But the other side to these businesses, is that they have spotted an opportunity to “buy” high quality invoices from major blue chip companies at a very low rate of interest. They target large quoted companies with very good debt ratings and high quality customer bases. The supplier companies are not firms that cash constrained.
In fact, to qualify for the lowest rates these companies need to have huge surpluses of cash. The attraction is that they can legally “sell” their current receivables, i.e. not yet due, and earn a modest rate of interest. This allows their treasury department to turn accounts receivables into a performing asset and at the same time takes a chunk of working capital off the balance sheet. The only limitation on these exchange businesses is their access to funding and market footprint of their offerings.
So far these businesses have shown success in the United States, but these services are emerging in Europe and other regions through the expansion of current players’ footprints and the entry of new players to the market.
So if you are a large blue chip company in a country with a solid credit rating, you are about to get yet another avenue to cheap and available credit. In this scenario, dependent on the jurisdiction of your company, you will also be able also be able to take these receivables off balance sheet, since you are are selling them to an unrelated third party. This raises the prospect that large companies will in effect be able to deliberately understate their trade receivables positions in a perfectly legal manner.
But, if you are a smaller enterprise or a larger company that is not considered to be top rated by the markets, you can still participate in these exchanges, but don’t expect to get as cheap a funding route as your more robust large blue chip brethren. But even so these services should offer a slightly cheaper form of finance to supplier companies than traditional factoring.
So here is another opportunity that has emerged based on a mixture of technology and the availability of cheap credit that seems to be more favourable to large robust corporate than cash constrained companies.