In our previous post, we discussed how financial institutions are building accounts receivable (AR) businesses. Let’s rewind and cover the basics of how AR works, what its true value is to banks and asset managers, what has led to its rise in prominence, plus what LiquidX’s technology can do to help you scale quickly and efficiently.
How Does Accounts Receivable Financing Work?
AR is a type of financing agreement involving the balance of money due to a firm for goods or services delivered or used, but not yet paid for by customers. In other words, a business sells its accounts receivable (i.e., invoices) to a financial institution at a discount.
AR is listed on the balance sheet as a current asset in the short term. Current assets refer to those that are liquid, as in they can easily be converted to cash in less than a year. AR is typically collected in two months or less. Since AR is a key component of working capital, it is a company’s most valuable asset. It is the lifeblood of an organization, as a business’ cash flow and profitability depend on it.
How Do Financial Institutions Benefit from Building their Own Accounts Receivable Programs?
Financial institutions use their AR businesses to power growth. Offering AR services can be a strategic and profitable endeavor for financial institutions, providing them with opportunities for revenue growth, risk management and enhanced customer relationships. Below is a breakdown of the advantages:
- Diversification of revenue streams: AR allows you to diversify your revenue streams beyond traditional lending products like loans and mortgages. As a variable rate product, AR financing can help mitigate risks within the financial institution’s overall portfolio associated with fluctuations in interest rates or economic cycles.
- Competitive advantage: In competitive banking markets, offering AR services can differentiate your financial institution from your competitors. Discounting invoices can be particularly attractive to businesses in industries with long payment cycles or seasonal fluctuations in cash flow. By providing a solution to these challenges, you can attract new clients and retain existing ones.
- Risk management: Financial institutions offering AR services often have robust risk management processes in place to assess the creditworthiness of clients and the quality of their AR. By carefully evaluating potential clients and their invoices, you can mitigate the risk of non-payment or default.
- Customer relationships: AR offers businesses access to working capital, which is crucial for their growth and success. By being able to facilitate this for customers, financial institutions can build stronger, long-term relationships with them.
- Liquidity management: AR allows you to manage your liquidity more effectively. By purchasing AR from businesses and providing them with immediate cash, you can deploy your own funds efficiently and generate steady returns on these assets.
What’s Behind the Rise in Receivables Finance?
Over the past several years, numerous influences have propelled AR into an even more strategic role in global finance:
- Global pandemic
- Turbulent economy
- Large banks tightening their lending standards
- Capital requirements limiting large banks’ ability to support certain groups of clients, such as those deemed riskier or requiring higher capital allocations
- Increasing cost of capital
- Evolving supply chain dynamics
- Geopolitical uncertainties
All of these have affected how corporates get access to working capital. Corporates have been turning to alternative sources such as AR. AR provides corporates with flexibility and liquidity by leveraging their AR to access financing when traditional sources are costly or not available. A survey done by Treasury Webinars on behalf of BlackLine shows that 71% of companies plan to increase the responsibilities of their AR teams this year. This shift has created an immense opportunity for banks to create their own AR programs.
Getting the Most Out of Your AR Business
With efficient technology, information management, record keeping and proper tracking, the financial institution can scale its business quickly, efficiently and with effective risk management.
Key considerations when building your business:
- Unlike an asset-based loan or traditional unsecured loan, banks aren’t dealing with a single credit, you’re handling a group of credits. Analyzing that group of credits and understanding the risks on a multi-dimensional basis are keys to success.
- When you have cash coming in from multiple sources depending on the credit quality of the supplier, it can be beneficial to establish a lockbox to help you control the cash flow and preserve your interest in not only the receivables, but the payments that come out of those receivables as well.
- Managing the volume and frequency of offers from the seller and reconciling payments from the obligors to the invoices sold to the financial institution is key to effective risk management and a key component of LiquidX’s technology solution suite.
LiquidX designed our trade finance software to make the AR process as streamlined and efficient as possible. We deliver real-time data that synchronizes with upstream and downstream processes for more powerful and accurate analytics.
Our white-label offering, the LiquidX Partner Program (LPP), enables financial institutions to use our technology, framework and settlement infrastructure to privately transact with your clients. For financial institutions with existing trade finance infrastructure, we can deploy individual modules of LiquidX for transacting with your clients in a private, branded environment, or deploy our digitization technology for automating middle-office and back-office processes, and providing visibility into the underlying assets in trade finance transactions.
To learn more about the LPP, click here.
