Strategic consultancies of the calibre of McKinsey are dedicating thorough studies to the topic of receivables and examining how to use cash management techniques to release finance. They have come to the conclusion that financial institution revenues generated by receivables finance will increase over 400% between now and 2020, growing from about US$9bn today to almost US$40bn.
But why are these financing practices, once used only in a small market niche and the supply chain, now becoming mainstream? Has the perception of the market changed? Have the needs of the corporates evolved? All of these factors are true and they have contributed to the proliferation of finance products now centred around receivables, such as securitisation, factoring and forfaiting.
Changing Perspectives in the North: Factoring
Factoring has been used for decades as a normal business practice in southern European countries. In the neighbouring economies of northern Europe, however, this financial service has long been underutilised. While in the south factoring was acknowledged as an efficient way to manage the sales ledger and reduce working capital, corporate treasurers and other finance professionals in the north still perceived it as a sort of financing of last resort – something almost to be ashamed of. While the perception gap is now narrowing, the penetration of factoring as a percentage of gross domestic product (GDP) is still rather different between the two regions: in the large southern European economies, such as Italy and Spain, factoring volumes reach about 11-12% of the respective GDP, while in Germany, Holland and Sweden the ratio is only around 6-7%.
The considerable use of factoring in southern Europe has certainly much to do with the average payment morale of the local corporates. For example, while German buyers would usually pay within 30 days and on average let only one out of four invoices run overdue, Italian or Spanish companies would often negotiate payment terms up to two or three times longer and would on average pay almost half of their trade payables late, according to a Dun & Bradstreet (D&B) business information survey last year.
The introduction of factoring allows sellers to outsource the management of their accounts receivables to professionals, who know how to optimise the collection process and can advance funds to bridge the time lag until the debtors fully repay their balances.
Things started to change in northern Europe following the financial crisis in 2008. A larger number of corporate treasuries tried out factoring for the first time, looking for a solution to cope with the liquidity constraints and the risk of insolvencies of many buyers. In most of the cases, the experience was very positive and the companies stuck to their factoring contracts after the immediate need had passed. Barclays talked to one of the factoring firms that won numerous new clients in Germany, and they explained: “First, they all came for the money, fearing that most of their trade debts wouldn’t be repaid. After having seen how effective the support of a factoring house can be in the management of receivables, though, they decided to stay for the service”.
New Corporate Needs in a Riskier World
The trade patterns in Europe have also started to shift under the effects of the eurozone crisis. Corporates have adjusted their sourcing and selling behaviours, shaping a new landscape where customers and suppliers have to find a new orientation, and sometimes raise funding themselves. In Germany, for example, exports to the south of the European Union (EU) were down approximately 9% in Q4 2012, while at the same time exports to emerging markets outside the EU rose by almost 2%. Notwithstanding the weak demand from Italy, Spain, Portugal and Greece, the overall export figures for Germany ended last year on a positive trend, meaning that the fading appetite of old neighbouring customers has been effectively replaced by the voracity of new clients in Asia, the Middle East and Africa (AMEA).
According to studies by the World Trade Organisation (WTO), 10 of the 25 most important trade corridors predicted for 2030 will be made by new trade relationships that have just started to emerge, with countries such as Nigeria, India, Saudi Arabia and the United Arab Emirates (UAE) as key players. Growing ‘south-south’ trade will be important.
This trend towards the discovery of new markets and the expansion of businesses trade activities into untapped territories will continue throughout 2013, playing an important role in mitigating the effects of the slowdown in the eurozone economies. As a result, businesses now face a new economic reality that is rapidly becoming highly diversified, less predictable and more complex – in one word: riskier.
Factoring and receivables finance is one of the tools that many treasurers and chief financial officers (CFOs) have recently discovered in northern Europe in order to effectively manage this increased risk. It used to be seen as a last resort but increasingly isn’t. Looking through their own international receivables books, financial departments are now getting more resolute about tackling the burden of uncertainty they carry: unknown payment dates, buyer’s default risk, foreign exchange (FX) or even redenomination risk. The hidden costs of administering these risks is huge, especially considering that accounts receivables (A/R) often makes up as much as 40% of a corporate’s entire working capital and that the continuing global macro-economic volatility imposes an even closer monitoring and analysis of their status.
Selling receivables to a financial institution solves many problems and at the same time cash flows become more predictable, liquidity ratios improve and risks related to the collection are eliminated. Once you go down this road, however, a treasurer’s room for manoeuvre has been limited.
Receivables under Basel III
The last major factor that Barclays thinks is contributing towards making receivables more appealing is the impact of new financial regulations, such as the Basel III capital adequacy regime. The new set of rules for banking institutions is changing the way banks look at some of their traditional business lines.
Plain vanilla lending is losing importance as a form of working capital finance, due to the relatively high consumption of capital. Everywhere banks are trying to work preferably on the basis of uncommitted, short-term facilities, ideally supported by self-liquidating assets that can also be sold down to the secondary market, if necessary. All these characteristics match perfectly with the profile of receivables finance, which is consequently moving up to the top of the agenda of all commercial banks. That doesn’t necessarily mean it is the best deal for corporate treasurers, however, and each case should be examined on its own merits but it does show banks’ willingness to support factoring.
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