The Treasurer’s Guide to Trade Finance

Chapter 7 Trade financing techniques

would face the loss of its working capital

finance. (Under a factoring arrangement,

the company would face the loss of both

the receivables, taken as security, and the

revenue stream from its customers.) The

accounting treatment will vary according to

the terms of the agreement. In most cases,

invoice discounting agreements do not fully

transfer the risks and rewards associated

with the invoices to the discounter, so the

company has to account for the funding as a

loan. Because of the potential complexity of

individual transactions, specialist accounting

advice should always be sought.

The invoice discounting process

A typical invoice discounting process is as

follows.

ƒ The company raises an invoice.

ƒ The invoice is sent to the customer and

copied to the invoice discounter.

ƒ The invoice discounter approves the

invoice and pays the agreed proportion to

company.

ƒ The company collects payment from

its customer, with the cash going into

a designated account over which the

discounter has priority rights. Once

payment is received, the company refunds

the invoice discounter, including fees and

interest charges. In some cases payment

will be advanced on a monthly basis. If

the value of invoices issued has increased

over the month, the discounter will pay the

company. If the reverse is the case, the

company will repay the discounter. This

will be at the same proportionate discount

rate as initially agreed.

The invoice discounter will levy interest

charges and a fee. Interest charges will be

set at a pre-agreed margin over the relevant

local base rate, and will be charged on the

amount outstanding. Fees are usually a

function of the company’s turnover (anything

from under 1% of turnover to 2%), and

perhaps the number of customers or invoice

cycles per year, which may be stepped to

adjust for a company’s growth.

Since 2008, invoice discounting services

have become available via internet-based

auction sites. These differ from traditional

invoice discounting services as the borrower

is not committed to a particular invoice

discounter. Instead, participants in the auction

bid against each other on both the proportion

of the value of the invoice and the discount

charge, to the benefit of the borrower, as long

as a lender is available to lend against the

invoice. At present, these services are only

suitable for SMEs, with financing primarily

provided by high-net worth individuals and

hedge funds.

Advantages

There are a number of advantages from

invoice discounting.

ƒ It provides clear working capital finance

at the time it is needed, not according

to the terms of a loan agreement or

overdraft.

ƒ Finance is provided against invoices so,

subject to any credit limit, finance can be

available as a company grows.

ƒ Invoices are reserved for short-term

working capital financing, meaning other

assets such as property are available

to secure other, perhaps longer-term,

financing.

ƒ Once the invoice has been approved, the

company has access to cash which can

then be recycled back into the business.

There is no requirement to use overdrafts

or other unsecured funding to bridge delay

in payment terms.

ƒ The scrutiny of the invoice discounter

can help to improve the company’s credit

management policies and accounts

receivable processes.

ƒ Unlike factoring, invoice discounting is

usually not disclosed to the company’s

clients, meaning the company maintains

the critical trading relationship with its

customers throughout the sales process.

Disadvantages

As with any other form of financing, there

are disadvantages to the use of invoice

discounting.

ƒ Invoices are among the most attractive

formal or informal sources of security for

lenders. It may be difficult to raise other,

especially short-term, finance if invoices

are committed to an invoice discounter.