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Uzņēmējiem - 2020 11 20
faktorings | uzņēmējdarbība

How to strengthen the company’s supply chain, using the available financial instruments?

How to strengthen the company’s supply chain, using the available financial instruments? SEB bankas vecākais faktoringa produktu darījumu vadītājs Jānis Moisejs

Despite the experienced economic instability, when many Latvian companies had to seek ways to streamline or even terminate their businesses, there are companies that are capable of adapting to the current situation and benefiting from the existing circumstances to attract new financing.

The operations of the business can be financed not only with working capital loans, but also with the help of factoring, i.e., invoice financing. We are speaking of invoices issued by the company for receivables due from customers as well as of supplier invoices payable by the company. First, let’s look at the second option, reverse factoring.

Why consider factoring?

Bank financing always involves certain costs in the form of interest or commission charges. It is therefore important to analyse, together with the bank, which types of financing will be the most appropriate for the company’s circumstances and financial well-being. If a company engages in business with a financial institution thoughtfully, the company’s well-being should generally improve.

While, to some extent, reverse factoring is a new type of financing in Latvia, it is widespread in the large Western European economies. According to the Factors Chain International data, last year, the volume of domestic reverse factoring went up by over 55% globally, which supports the growing popularity of this solution.

How does reverse factoring work?

In essence, under a factoring arrangement, the financier buys the right to the receivables (invoices) from the company’s supplier, which the merchant has already accepted, by paying the billed purchase price to the supplier instead of the company. The company can still pay for the purchased goods or services within the payment deadline initially specified on the invoice, however, the payment will not be made to the supplier, but rather to the financial institution that purchased the obligation to pay the invoice on behalf of the merchant.

There is a significant added value in this solution in cases when the buyer and supplier have different credit risk ratings.

Usually, in reverse factoring, the customer is a company with a very good risk rating, e.g., state-owned companies, international organizations or local companies with a high turnover and sound financial performance.

Conversely, the supplier usually is a new company, or a company that has already assumed large financial commitments which has weakened its risk rating, and additional financing may not be available at all. Thus, the credit risk rating of the two companies differs significantly. This in turn creates an opportunity for risk arbitrage, i.e., risk restructuring.

How does this work in practice?

Using the reverse factoring solution, the financial institution receives a confirmation from the buyer or a financially sound company that the submitted invoice will be paid within a certain deadline. Consequently, when pricing the financial resources, the financier assesses only the buyer’s credit risk. In this scenario, the price of credit risk will be much lower for the buyer rather than for the supplier, for which the costs of raising financing may be higher many times or financing may not be available at all.

At this point, the potential benefits might emerge. Namely, had the supplier been able to attract financing for the price of the buyer’s credit risk to his company, it would be ready to give the buyer a certain discount on the purchase or extend the original payment dates specified on the invoice.

If the bank paid the invoices immediately by transferring the money to the supplier, deducting financing costs by reference to the buyer’s rather than the supplier’s credit risk, the supplier would be willing to cover all financing costs, as it would be much more cost effective rather than turning to the financier with its credit rating.

In addition, if the credit risk difference is significant, a purchase discount or payment extension dates can be agreed with the supplier, which would release the working capital in the buyer’s company. Thus, using the good credit rating, the buyer can support its supplier as well as improve its own financial position at no extra costs to the company.

In the financial cycle phase, when there is a lot of uncertainty in the market or when macroeconomic indicators signal a recession, the difference in the available price for financial resources for large and smaller companies increases. Therefore, reverse factoring is currently a particularly relevant solution for strengthening supply chains.

Is and where the reverse factoring solution currently used?

Currently, the major industries using reverse factoring are: telecommunications, IT, agriculture, retail and construction industries. Seeing the positive impact of reverse factoring on the economy in its various cycles, SEB banka, being the leading corporate financier, has been discussing reverse factoring opportunities with large Latvian companies as well as the leading companies in the SME segment aimed at strengthening or improving their supply chain financing.

When the classical factoring should rather be used?

However, if reaching an agreement on the implementation of a reverse factoring programme with a financially strong buyer is not feasible or if the buyer’s credit rating is poor, a great way to provide the company with working capital for the goods and services sold while awaiting payments against the invoices, is classic factoring. Using this solution, credit risk is determined by reference to the seller’s, i.e., the customer’s risk, while reducing the buyer’s involvement to the minimum. Namely, the buyer is not required to sign any deeds, it suffices with a simple note on the invoice indicating a change of the payee.

The classic factoring solution offered by SEB is one of the most competitive solutions on the market. This is supported by the increase in its market share and the fact that customers have been increasingly choosing this solution with the bank. For example, according to SEB banka’s performance in October, in the SME segment, the amount of the issued additional classical factoring increased by 51% compared to the same period of the previous year. This is based on the bank’s strategy to offer sustainable solutions to customers under the Covid-19 crisis circumstances, supporting the cash flows of businesses. This increase can also be due to the advantages of the classical factoring solution (receiving cash against the issued invoice immediately, reduction of currency risk through widely available invoice financing currencies, the possibility to insure against the debtor’s insolvency, easier product launching – without commercial pledges or other additional collaterals required, as well as other significant benefits). The application process has also become more convenient and can be effected remotely. The portfolio has grown mainly in the segment of customers that have transferred from other banks and new customers.

The factoring market has been developing dynamically in the non-banking segment, which raises the overall awareness of the factoring solution in the market. Compared with Lithuanian and Estonian factoring markets, Latvian market is 2 to 3 times smaller, which also explains the activity of the new factoring companies in Latvian market. Surely, non-banking solutions are much more expensive. Therefore, we encourage companies that have been operating for at least one year, to apply for a classic factoring offer in a larger bank before selecting the financier. We have also observed that customers do appreciate SEB’s wide customer base, which helps us quickly resolve issues relating to receivables and find solutions under the most challenging market conditions.

Jānis Moisejs
Senior factoring product business manager at SEB

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