a workshop program designed for financial institutions based... · supply chain finance accounts...

A workshop program designed for financial institutions

1

Imtiaz Ahmad

Consultant, NatLaw

August 26th & 27th, 2019

Introduction

2

Situational Perspective:

Background/Current State of the Secured Transactions Order (STO)

Framework and the Collateral Registry

3

SME Lending

Why is it important?

Successes in other economies

4

SME Finance Gap

5

There are

400 millionSMEs in developing countries

50% are unserved

or underserved

only 14%have a loan or line

of credit

Source: World Bank Group

SME Finance Gap

6Source: World Bank Group

Secured Transactions Systems

7

Bank Accounts

AccountsReceivable

Inventory andRaw Goods

Intellectual Property

Rights

Industrial and Agricultural Equipment

Durable Consumer Goods

Agricultural Products

Vehicles

Collateral Gap

8

Capital Stock of

Firms

Collateral Taken by Financial

Institutions

Mismatch between assets owned by companies and collateral required

73%

27%

Land/

Real Estate

Vehicle/

Machinery/

Equipment

Accounts

Receivable Land/

Real Estate

Movable

Property

Movable

Property

22% 44%

34%

78%


Why are financial institutions not willing to take movable property as collateral?

9

Because there is a lack of

Legal framework Registry of security

interests in movables

Know-how on

movable asset lendingInterests

Benefits of a Solid Secured Transactions System

10

Increases access to credit reducing the risk of credit

Reduces the cost of credit

Increase market competition

Promotes credit diversification

“Collateral Registries for Movable Assets: Do they Spur Firms’ Access to Finance?”

11

ACCESS

TO

FINANCE

ACCESS

TO

LOAN

INTEREST

RATES

WORKING

CAPITAL

FINANCED

BY BANKS

LOAN

MATURITY

-3 +7 +8 +10 +6MonthsPercentage points Percentage points Percentage points Percentage points

Study also provides evidence that the impact of the introduction of

movable registries on firms’ access to finance is larger among

smaller firms, who also report a reduction in subjective, perception-

based measure of finance obstacles.Source: World Bank Group

Potential Effect in Secured Transactions

12

The end result would be greater access to credit to SMEs, more jobs

created and increased competition in the financial marketplace.

Improved legislative framework governing

secured transactions which is more

transparent, efficient and comprehensive.

New registry with robust platforms,

proper capacity and wide usage.

Increased capacity of financial

institutions to design and offer new

products where movable assets are used

as collateral.

Principles for Effective Secured Transactions

13

Effective Secured

Transactions System

Broad scope

Creation

Publicity / registration

Priority

Enforcement

Doing Business “Getting Credit” Indicator

14

Borrowers and Creditors Right Index

(0-12)

OECD

Europe & Central Asia

East Asia & Pacific

Latin America &

the Caribbean

South Asia

Sub-Saharan Africa

Middle East & North Africa

Low High

6

6.4

6.6

5.3

4.6

5

2.2


Global Collateral Registry Projects

15

• Implemented new Secured Lending

Law in 2013 and established new

centralized collateral registry in

March 2014.

• More loans registered in the first 6

months of implementation than in

the last 30 years. More than 445,000

loans registered for a value of more

than US$ 1 trillion.

Colombia China

• Legal reform was implemented in 2007

and Registry launched in 2008 covering

accounts receivable and leasing.

• More than 10.4 trillion dollars in

financing with accounts receivable

(mostly for SMEs). Development of the

factoring and leasing industries.


Global Collateral Registry Projects

16

• Legal reform and new centralized

online registry, which launched in

March 2012, has provided 675,000

loans to more than 354,000 SMEs and

20,000 micro-enterprises.

• Total volume of financing through

the registry is US$ 27 billion.

Vietnam Mexico

• Law reform and new centralized online

registry launched in October 2011.

• Over 150,000 loans have been

registered for a total secured amount

estimated at over USD$200 billion.

Loans secured with movables have

grown fourfold.

• 45% of the loans to the agricultural

sector and 95% to SMEs. Businesses

have saved US$4 billion in fees.Source: World Bank Group

Ghana: Impact on SMEs - Supply Chain Finance

17

CAL BANK:

Purchase Financing

Scheme for Gold Mining

Developed a local supply chain for big mining corporations, through

local SME service providers

• More than 100 local SMEs have received more than US$ 10

million. Created hundreds of new jobs.

• SMEs use movable assets (contracts, receivables, equipment) as

collateral.

• No defaults in the 30 months that program has been operating.

Number of loans registered 77,500

Value of loans registered US$ 20 billion

Number of SMEs 8,000

Number of microenterprises 30,000

Collateral by type

25% inventory and receivables

20% household goods

19% vehicles


The Art of the Possible

New Financial Products for SMEs

Overview

18

Enabling Framework

19

Lending

Products

Borrowers Lenders

PlatformsBank

Regulation

Secondary

Market

RegistryLegal

FrameworkEnforcement

Movables Finance Matrix

20

FINANCIAL INFRASTRUCTURE

TIT

LE

TR

AN

SA

CT

ION

LA

WS

SE

CU

RE

D T

RA

SA

CT

ION

LA

WS

COLLATERAL

REGISTRY

ENFORCEMENT

SYSTEM

BANKING

REGULATION

SECONDARY

MARKET

FINTECH &

TRADING

PLATFORMS

POTENTIAL

CREDIT

PRODUCTS

POTENTIAL

COLLATERAL

POTENTIAL BORROWERS

Consumer Financing Financial Leasing Equipment Financing

Inventory Finance Merchant Financing Factoring

Supply Chain Finance Accounts Receivable Financing ABL: Secured Lines of Credit

Warehouse Receipt Financing Securities Lending Others

Motor Vehicles

e-Payments

Raw Materials Inventory

Accounts ReceivableNegotiable

InstrumentsCash Bank Deposits

Bills of LadingWarehouse Receipts Letters of Credit Securities

Equipment

Fintech & Digitized

AssetsOtherCredit Card Receipts

Consumers

SMEs

Informal Enterprises

Corporates Special-Owned Business

Micro-Businesses

Movables Finance Matrix

21

FINANCIAL INFRASTRUCTURE

TIT

LE

TR

AN

SA

CT

ION

LA

WS

SE

CU

RE

D T

RA

SA

CT

ION

LA

WS

COLLATERAL

REGISTRY

ENFORCEMENT

SYSTEM

BANKING

REGULATION

SECONDARY

MARKET

FINTECH &

TRADING

PLATFORMS

POTENTIAL

CREDIT

PRODUCTS

POTENTIAL

COLLATERAL

POTENTIAL BORROWERS

Consumer Financing Financial Leasing Equipment Financing

Inventory Finance Merchant Financing Factoring

Supply Chain Finance Accounts Receivable Financing ABL: Secured Lines of Credit

Warehouse Receipt Financing Securities Lending Others

Motor Vehicles

e-Payments

Raw Materials Inventory

Accounts ReceivableNegotiable

InstrumentsCash Bank Deposits

Bills of LadingWarehouse Receipts Letters of Credit Securities

Equipment

Fintech & Digitized

AssetsOtherCredit Card Receipts

Consumers

SMEs

Informal Enterprises

Corporates Special-Owned Business

Micro-Businesses

Types of Lending with Movables

22

SME Financing

Financial Leasing

FactoringAsset Based

Lending

Supply Chain

Finance

Inventory Finance

SME Financing

23

SME Cash Cycle / Collateral

Payment

Sale of

Product

Transformation

Process

Purchase Raw

Materials

24



Factoring

25

Factoring

26

LEARNING OBJECTIVES

Focused objective is to gain a firm understanding of factoring

and enhance skills, in order to sell, utilize and process factoring

transactions in line with established standards;

Equip participants with sufficient knowledge to understand and

avoid operational risks involved in invoice financing;

Provide micro lenders and banks and their clients with a sound

understanding of factoring principles, allowing them to better

structure trade transactions, improve risk assessment skills and

identify opportunities where factoring could be utilized as a

financing tool to facilitate the optimization of clients’ trade

activities.

Factoring

27

LEARNING OUTCOMES

At the end of the training, participants should be able to:

Gain knowledge on factoring and how it works;

Gain deepened understanding on why businesses factor;

Gain understanding on what factors look out for before signing

clients on;

List the factoring process and explain the techniques to

establish productive factoring relationships.

Factoring

28

Factoring

29

What is factoring?

How does it differ from commercial lending?

Who are sellers in this context?

Who are clients in this context?

Who are account debtors in this context?

Factoring

30

" refers to:

the outright purchase and sale of accounts receivable

(A/R) invoices at a discount from their face value.

the structure, terms and conditions of such a

transaction may vary in any number of ways, as

evidenced by the array of factoring programs currently

available.

Factoring Definitions

• Factoring is a transaction in which a business sells its invoices, or receivables, to a third-party financial company known as a “factor.” The factor then collects payment on those invoices from the business’s customers.

• Factoring is also called “Purchase of Receivables”.

• The main reason that companies (Sellers) choose to factor is that they want to receive cash quickly on their receivables, rather than waiting the 30 to 60 days it often takes a customer (Obligor/Account Debtor) to pay.

Source: http://www.rtsfinancial.com/guides/what-factoring 31

Factoring Definitions

• When factoring an invoice, the factoring provider advances to you (Seller) a percentage of that invoice value, usually within 24 hours. The factor will then pay the balance of the invoice, minus fees, after it collects payment from the customer (Obligor/Account Debtor).

• The cash advance rate can vary depending on what industry the client (Seller) company is in and which factor is chosen. The advance rate can range from 80% of an invoice value to as much as 95%. The client (Seller) industry, the customers’ (Obligor/Account Debtors’) credit histories and other criteria help determine the advance rate received. 32

Factoring Benefits

• Boosting cash flow is the main reason most companies factor.

• Factors provide free back-office support, including managing collections from customers.

• Factoring is based on the quality of the customers’ (Obligor/Account Debtors’) credit, not the client’s (Seller’s) credit or business history.

33

Factoring Benefits

• Factoring can be customized and managed so that it provides necessary capital it is needed (seasonality).

• Factoring is not a loan, so no debt is incurred debt when factoring.

• Factoring is scalable, meaning the amount of funding can grow as receivables grow.

Source: http://www.rtsfinancial.com/guides/what-factoring

34

Factoring

35

Forms of factoring programs include:

1. Maturity Collection with credit insurance

2. Factoring (purchase of invoice)

3. Account Receivable (AR) Financing

Factoring Definition

36

GOODS

INVOICES

BUY INVOICES

COLLECTIONS

Factoring Flows

Invoice

Sale +

Confirmation

FACTOR

SELLERObligor/Account Debtor

1. SME seller of goods or services delivers to Obligor/Account Debtor and sends invoice for sale

2. Obligor/Account Debtor confirms delivery and terms of invoice

3. SME discounts invoices with factoring company

4. Obligor/Account Debtor must pay factoring company and Seller notifies Obligor/Account Debtor of the transaction

37

Factoring Flows - Roles

FACTORSELLER Obligor/Account Debtor

• Can be

• Bank

• Non-Bank

• FinTech

• Also called “Factoring

Provider”

• Purchases receivable

from Seller

• Can be

• Manufacturer

• Farmer

• Producer

• Service Provider

• Large or Small Business

• Also called “Client”

• Is originally owed payment

from the Obligor/Account

Debtor for product or

services purchased

(Creation of Receivables)

• Can be

• Distributor

• Retailer


• Government

• Also called “Customer” or

“Debtor”

• Originally owes payment to

the Seller for product or

services purchased

38

Factoring Flows

Invoice

Sale +

Confirmation

FACTOR




3. SME discounts invoices with Factor

4. Seller notifies Obligor/Account Debtor of the transaction and Obligor/Account Debtor must pay Factor

39

Factoring Flows

Invoice

Sale +

Confirmation

FACTOR






40

Factoring Flows

Invoice

Sale +

Confirmation

FACTOR






41

Factoring Flows

Invoice

Sale +

Confirmation

FACTOR





4. Seller notifies Obligor/Account Debtorof the transaction and Obligor/Account Debtor must pay Factor

42

To Lend or Purchase Receivables?

43

Factoring Benefits

• Allows a company (Seller) to improve their cashflow

• Gives a company (Seller) control over their risk of Obligor/Account Debtor default

• Provides a company (Seller) balance sheet relief regarding Accounts Receivables

• Enables Obligor/Account Debtor to pay on normal terms without pressure from Seller

• Gives a financial institution a secure mechanism for ‘financing’

• Factoring (done right) can be very profitable

44

Factoring

45

Companies engaged in the business of buying accounts

receivable are called "Factors." It often exhibits a

flexibility and entrepreneurial awareness whose

activities are more generally restricted by regulation

and prevailing law.

Factoring

46

Companies selling their receivables are typically

referred to as "clients" or "sellers" (not "borrowers").

The client's customers, who actually owe the money

represented by the invoices, are generally known as

"account debtors" or "customers.“

Factoring

47

Characteristically, there seems to be no industry-wide

term of art to describe the actual event that occurs

when a Factor accepts invoices for purchase. Common

terms for this event include: "schedule," "funding,"

"advance," "assignment" and "transaction."

Factoring

48

The cash which a Factor issues to a client as initial

payment for factored invoices is typically called an

"advance."

Factoring

49

Difference between factoring and commercial lending

Factoring differs from commercial lending because it

involves a transfer of asset (account receivable) rather

than a loan. In assessing risk, financial institutions look

primarily to the quality of the asset being purchased (i.e.

the ability to collect client receivables), rather than to the

underlying financial condition of the seller/client. Suitable

vehicle for growing businesses when traditional commercial

borrowing proves either impractical or unavailable.

Factoring

50

Factoring vs. Accounts Receivable (A/R) Lending

Although factoring is occasionally confused with

accounts receivable (A/R) lending, it actually differs

both legally and operationally.

Factoring

51

LEG

ALLY

Factoring AR Lending

A factor takes immediate title

to the invoices it purchases.

An A/R never takes title to

invoices unless and until the

borrower defaults on its loan

agreement.

With the transfer of title, the

factor purchases the right to

collect payments directly from

account debtors, who thus

become legally obligated to the

factor.

An A/R loan does not legally

obligate account debtors to pay

the lender directly, except

when the lender notifies them

of a default by the borrower.

Factoring

52

OPER

AT

ION

ALLY

Factoring AR Lending

The Factor concentrates on the

aging, collection, and posting of

each factored invoice.

The A/R lender does not track

the payment status of every

individual invoice generated by

the borrower in the normal

course of business.

The factor will find it necessary

to contact individual account

debtors directly as a matter of

course.

An A/R lender will have

virtually no interaction with

individual account debtors.

Factoring

53

Recourse vs Non-recourse

What happens when an account debtor becomes

financially unable to make payment for an

outstanding invoice that a factor has purchased?

The answer depends on whether the Factor operates on

a Recourse or Non-recourse basis.

Factoring

54

A Recourse transaction allows the Factor to make claims

against the client in order to recover losses caused by

account debtor insolvencies. Recourse factoring

agreements generally require the client to repurchase any

invoices that remain unpaid after a certain number of days

(typically 60 or 90).

Factoring

55

In a Non-Recourse transaction, the Factor purchases the

underlying credit risk associated with each factored

invoice. The client incurs no liability to the Factor if the

account debtor proves financially unable to make

payment. In such an event, the Factor either absorb the

loss, or enforces action against the account debtor.

Non-Recourse Recourse

Guarantee debtor credit Client refunds uncollected

invoices

May not be many opportunities

in Brunei

Well suited to smaller

situations

Service depends on the client’s greatest need

56

Need to manage risk Needs access to cash

Factoring

Factoring

57

Events Undertaken in Factoring Process

Factor approves account debtors' credit

Client submits invoices

Factor receives and processes invoices

Factor verifies invoicesFactor disburses

advances

Factor notifies debtors

Factor tracks invoice performance and collects payment

Factor deposits and posts payment

Factor disburses rebates to client

Factor reports to client

Factoring

58

THE FACTORING PROCESS

Once the Lender and the client have executed formal agreements, and pursuant to credit due diligence, approval process, and perfection of security interest, the day-to-day factoring relationship begins in earnest.

The specific process by which a client submits invoices, draws advances and receives reports will depend on the type of factoring program, the size of the Lender’s operation, and the quantity of client invoices, etc.

Factoring

59

1. Factor approves account debtors‘ (client’s customer, obligor) credit

2. Client submits invoices3. Factor receives and processes invoices4. Factor notifies debtors5. Factor verifies invoices

Factoring

60

6. Factor disburses advances7. Factor tracks invoice performance and collects payment8. Factor deposits and posts payments9. Factor disburses rebates to client10. Factor reports to client

Factoring

61

Underwriting Criteria Assessed

Components of factoring underwriting/credit due

diligence include:

1. advance rate on receivables

2. the types and amounts of ineligible invoices

3. the overall cost of the facility and the fee structure

These elements are determined prior to funding, after a

review of a number of criteria. Knowing what these

criteria are will help manage both Factor’s and Client’s

expectations.

Factoring

62

Concentration of invoices- Defined as the percentage of

invoices attributed to one customer. For example; if your client

has $500,000 on its A/R aging with $250,000 owed by one

customer--that is a 50% concentration. Many funding sources

seek concentration limits of 25% or less with one particular

customer given the dangers of high concentrations which

include the possibility of this very large customer going

bankrupt or pulling their business. It also not uncommon to

allow up to 100% concentrations. Higher concentration limits

lead to much higher rates or lower advance rates. A question of

risk appetite.

Factoring

63

Contras-Term refers to situations where a client buys from and

sells to the same customer/company, which means they have

A/R from and A/P with each other. This is a problem because

the invoices owed by these customers are suspect. For

example, Factor asks account debtor for payment on an invoice

and account debtor then deducts from their payment what the

client owes them. This means that invoices in contra situations

may not be worth what they appear to be on their face. Thus,

when reviewing a prospect, Factor needs to look at both their

A/R and A/P agings to see if the same business name(s) appear

on each. If they do, it’s a potential contra which makes the A/R

invoices ineligible.

Factoring

64

Payment Terms- Factoring companies use “recourse” factoring

where the client must buy back the invoice from the factor

with a replacement invoice if payment is not received timely.

Terms offered by client and their ability to collect their

invoices in a timely manner can greatly affect both the volume

of invoices purchased by the Factor, and the cost per invoice

(since cost for the invoice financing is based on how long the

invoice is outstanding). For example, if client offers its

customers 90 day terms and the Factor is unwilling to adjust

the period of time for which an invoice is acceptable (typically

90 days from invoice date) then it would not make sense for

the Factor to purchase invoices as they will likely all be

recourse at 90 days.

Factoring

65

Progress Bills and Pre-Bills- If a client is involved in construction,

software development, web site development, janitorial services,

large machinery manufacturing or is an internet service provider

there is a strong possibility that they issue progress bills or pre bills.

Progress bills are invoices for a certain portion of a job completion

and usually involve a “milestone” of some type or are based on a

“percentage of completion” approach. For example, a software

development firm might have a $1,000,000 project to build a custom

software application. Each month they might bill the “approximate”

amount of the job completed that month. The invoices may be

allowed by contract’s terms, but Factors look at what happens if the

borrower fails. In the event of a failure, it’s very unlikely that the

customer will pay for partially completed work as they will have to

find a replacement firm to complete the work.

Factoring

66

Ineligibles Accounts Receivables means those accounts

receivables of the Company that the Company and

Factor mutually determine to be uncollectible as of the

Closing Date.

Factoring

67

Accounts 90 days past invoice date: Because factors and will

never know a client’s customers as well as they do, if an

invoice goes beyond 60 days from due date, there are greater

chances of that invoice becoming ineligible, due to risk of non-

payment. If an invoice has gone unpaid for two months, there

is most likely a "story" behind it, and a prudent Factor needs to

be risk averse.

Factoring

68

Foreign Accounts: Factors don't want to finance invoices

where the account debtor is domiciled out of the country.

This has become more of an issue as the velocity of

international business increases with advances in technology

and the internet. Factor’s thinking is that it will be difficult

to collect these accounts (in the worst case scenario)

because they don't understand the laws of the foreign

country and there may be a language issue, among other

things.

Factoring

69

Related Company Accounts: Factors that would be willing to

lend against invoices due from a company that has common

ownership with its borrower. There are many issues that make

this dangerous for a lender, but the biggest is fraud.

Contra Accounts: Client and account debtor buying and selling

to each other. The risk is offset on claim of the receivables

owed making the collateral a factor is advancing against

worthless.

Accounts Related to Product Samples or

Consignment: Factors make these ineligible for the simple

fact that most invoices for samples aren't paid, or if the

product sells then payment is made, otherwise it is a return.

Factoring

70

Accounts that are the product of lengthy contracts: Factors

aren't able to spend the time analyzing and monitoring a client’s

accounts, and may not have the expertise in their particular

industry to be comfortable when lending against lengthy

contracts.

Retention (Contractors): Retention is the percentage of payments for job in process that is held back to ensure adequate performance. Retention is considered ineligible because it takes a long time to collect and it is common for disputes to arise regarding payment.

Factoring

71

Bill and hold receivables: Client bills customer when

goods made, but holds them, possibly because their

customer may not have storage space due to seasonal

items. Difficult to finance transactions that are not

complete.

Non assignability clauses in purchase orders: Sales

agreements or purchase orders between client and it’s

customers sometimes have provisions stating receivables

cannot be assigned. This provision is not effective under

most collateral registry processes.

Factoring

72

Hidden or competing liens: If a client is a contractor or

sub-contractor that performs work backed by a payment

or performance bond, a Factor must be careful about

extending credit based on receivable. The bonding

company (the surety) may by means of subrogation,

obtain priority over perfected security interest (collateral

registry) over the borrower receivable.

To Lend or Purchase Receivables?

73

Lending on receivables

(ABL/AR Financing)

Recourse Factoring

Operationally more complex Simpler

Requires specialized cash

management through lock box

Debtor pays factor direct

Usually more cost-effective at

larger volumes

Works well for smaller clients

Factoring

Factoring

74

Primary Responsibilities of an Account Manager/Portfolio

Manager/Relationship Manager: Assist with due diligence and analysis of client relationships;

Ensure loan documentation is in good order;

Perform ongoing monitoring of credit compliance;

Communicate with borrowers to discuss their financial

situation, address concerns and obtain additional information;

Analyze and create financial transaction write-ups to generate

new loans with existing clients;

Ensure assigned portfolio of trade accounts follows established

policies and procedures;

Identify and escalate issues related to credit concerns;

Factoring

75

Assist management team with day to day operations;

Manage client and customer relationships by providing

advising, consulting, proactive communications on the

portfolio in lieu of the prescribed procedures and guidelines,

and meeting their respective needs promptly;

Collection, evaluation and processing of documents for

effective and efficient approval process;

Assess the risks and impacts for development and

implementation of an overall robust strategy for the program;

Manage verification, analytics and monitoring, compliance,

treasury and cash applications, collections default and

workout management processes;e reports;

Factoring

76

Provide weekly portfolio updates, reports and strategies to

management;

Effectively and proactively communicates across all levels of

the company;

Manage all funding and remittance activities by following the

prescribed procedures and guidelines of the program;

Process timely approved funding, identify remittances, cash

applications, cash disbursements;

Provide daily facts on past due payments, credits, short pays,

discounts, direct pays, and other lockbox information;date all

data and online reports;

Factoring

77

Required Skills: The individual must have the requisite skills.

Strong communication skills (oral and

written)

Ability to develop trusted

relationships with clients

Focus on client retention with

minimized loses

Dedicated work ethics

Strong attention to detail and

organization skills

Intermediate to advanced skill set

in Microsoft Office-Excel

Factoring

78

Risk Portfolio Management Process:

Analytics and Monitoring (Portfolio Management)

Various available reports from the platform may be

utilized to conduct the following. The primary objective of

these functions will be:

Quarterly review of Obligor/Account Debtor financial

condition and subsequent information updating.

Quarterly review of public records on Obligor/Account

Debtor and subsequent information updating.

Monitoring underwriting covenants

Concentration analysis.

Factoring

79

Analytics and Monitoring (Portfolio Management)

Proactive portfolio monitoring of AP/AR turnover, dilution,

transaction activities, and credit limits, DPO, DSO, industry

trends, risk ratings, and other key risk indicators and red

flags.

Remittance activities.

Obligor/Account Debtor and Client bank changes.

Monitoring of related parties/affiliations.

Monitoring of inconsistencies in relationships and funding

activities.

Factoring

80


Fraud & Compliance

It is necessary to conduct audit of the operations procedures to

ensure that they are being followed, and the audit of the paper

trail of all transactions.

Quarterly audits of procedures and operations.

Quarterly audits transactions, reconciliations, and paper trail.

Evaluation and action of red flags and fraud.

Data security.

Corporate wide standards for security and fraud prevention.

Ongoing credit files administration.

Factoring

81


Default, Collections & Workout

The following functions must be conducted as a routine

function, in order to avoid any payment defaults. Further, in

accordance to a Lender’s current default, collection, recovery

departmental policies and practices, this process will have

extensive involvement of DBJ’s legal department.

Weekly Portfolio AP aging review.

Past due AP monitoring.

Proactive collection approaches with enhanced

communications across all parties.

Target zero DBJ portfolio losses across all parties.

Constant evaluation of the processes to minimize insurance

claims.

Factoring

82

Risk Portfolio Management Process: Default, Collections & Workout

In order to avoid any payment defaults, the following functions

must be conducted as a routine. Further, in accordance to a

Lender’s current default, collection, recovery departmental

policies and practices, this process will have extensive

involvement of Factor’s legal services, as required.

Weekly Portfolio AP aging review.

Past due AP monitoring.

Proactive collection approaches with enhanced

communications across all parties.

Target zero DBJ portfolio losses across all parties.

Constant evaluation of the processes to minimize insurance

claims.

Factoring

83

Tools & Reports

Most platforms provide dashboards and multiple reports

delivering the performance of the Obligor/Account Debtors and

Suppliers activities. The following are some recommended tools

and reports that could be used to gather information for better

results of the above mentioned processes.

Tools

Criminal and civil searches

Public record searches

Google searches

Google alerts

Websites

Factoring

84

Collateral Registry tracking

Lexis Nexis searches (if the service is available and

subscribed); D&B searches (if the service is available and

subscribed)

Platform status changes, (i.e. risk rating, compliance,

non-compliance, delinquency etc.)

Tax Information Authorization (may not be applicable in

Brunei)

Factoring

85

In addition to necessary available platform reporting, the

following reports should also be accessed and reviewed to

ensure the strength of the portfolio. Remember that the target

is increased profitability, and minimized losses, efficient and

proactive, in line with global business objectives.

Reports

Outstanding transaction report

Trend analysis report

DPO and AP turnover report

Collection report

Concentration report

Dilution report

Factoring

86

Obligor/Account Debtor risk rating report

Obligor/Account Debtors AP Summary aging report

Factor/Client summary aging report

Client exposure summary report

1. Companies including SMEs often come to factoring through

the involvement of:

a. brokers;

b. management consultants;

c. accountants;

d. other referring parties.

Wrap Up And Key Learning Points

87

Factoring

2. Companies including SMEs enter into factoring

relationships to achieve goals such as:

a. accelerating cash flow to increase sales,

b. buying time to permit an orderly search for more

conventional financing,

c. weathering a start-up period, etc.

3. Factors enter relationships with clients to help them

achieve their goals.

Wrap Up And Key Learning Points

88

Factoring



Supply Chain Finance

Supply Chain Finance (SCF)

Lets take a looks at this and see what we get out of it.

https://www.youtube.com/watch?v=9CUKNbKNFj0

https://www.youtube.com/watch?v=6XUVfE1eaho

https://www.youtube.com/watch?v=9CUKNbKNFj0

https://www.youtube.com/watch?v=6XUVfE1eaho


Cash Conversion Cycle or CCC is the number of days that a business

entity takes to convert its input resources into liquid cash flow. This

metric aims to measure how much time a company takes to sell its

inventories, collect its receivables and pay off its bills without any

delay penalty being charged. Every dollar that is tied up to the

process of production till it is recovered as sales are scrutinized to

calculate the cash cycle of an entity. A lower number of days are the

most desirable when it comes to Cash Conversion Cycle.

CALCULATION

The length of a cycle can be measured using the following formula:

CCC = DIO + DPO + DSO Days

Where,

DIO = Days Inventory Outstanding

DPO = Days Payables Outstanding

DSO = Days Sales Outstanding

Sell finished product

CashCash Profit

Get paid

Pay debts to suppliers Purchase inventory

or raw materialsThe Cash

Cycle

The cash cycle


Inventory Sold and Accounts Receivable Set Up

CashRemaining

Cash to Bank

Accounts Receivable

Collected

Cash Used to Pay Accounts

Payable and Other Expenses

Used to Purchase Inventory, Set Up Accounts Payable

The Cash Cycle

Cash cycle with customer and supplier credit

Credit to customer:Payment terms

Credit from supplier:Payment terms


Inventory Sold and Accounts Receivable Set Up

Cash advance

from lender

Remaining cash repays

loan

Accounts Receivable

Collectedby lender

Cash Used to Pay Accounts Payable and

Other Expenses

Used to Purchase Inventory, Set Up Accounts Payable

The Cash Cycle

The end goal: Cash cycle with Lender, Buyer and Supplier credit

Credit to BuyerPayment terms

Credit from Supplier:Payment terms

Credit to borrower:

Revolving lineNOT aTerm loan



Objective: To provide working capital to Supplier by

enabling sale of account receivables on open

account terms – while enabling buyer to

improve working capital, or get better returns

on their cash

Most popular: Reverse Factoring - Supplier funded

through early payment (invoice amount less

discount fee) on Buyer approved invoices

Funded by a Bank, or Non-Bank financial

institution (Payables Financing)


AS A BUSINESS SOLUTION - Technology has played a

major role in the rise of reverse factoring. In the early

1990’s reverse factoring was only offered to large

corporate buyers. Also, only a handful of banks offered

this. With the rise in technology, there was a rise in

financial technology firms as well. Both banks and

financial technology firms started offering reverse

factoring not only as a means of finance but also as a

business solution.

Supply Chain Finance aka “Reverse Factoring”

SME Financing

Financial Leasing


Lending

Supply Chain

Finance

Inventory Finance

Supply Chain Finance (SCF) Concepts

• A set of technology-based business and financing processes that link the various parties in a transaction – the buyer, seller, and financing institution

• SME suppliers receive financing in relation to their receivables (money for goods/services delivered) by a process that is started by the ordering company

• Allows the supplying company (SME) to receive better finance terms than it would otherwise be able to receive from a lender

• The deal is based entirely on the credit-worthiness of the “Anchor” buyer


Simply put, Reverse factoring is when a lending institution,

interposes itself between a Buyer and its Suppliers, and commits to

pay the Buyer’s Accounts Payables (its Suppliers 'accounts

receivables) at an accelerated rate (often termed as “early pay” in

exchange for a discount, primarily driven by enabled technology

platform.

The Funder as a Paying Agent, funds a Buyer’s supplier receives in

relation to their receivables (money for goods/services delivered) by

a process that is started by the ordering company (Buyer). It allows

the supplying company to receive early payments on better finance

terms (discount fee) than it would otherwise be able to receive from

a lender on its own merit.

What is Reverse Factoring?

Workflow

1. Purchase order

•

2. Delivery

3. Invoice

S

U

P

P

L

I

E

R

6. Notification of

available funding

8. Request for

financing

9. Funding

11. Payment of non-financed invoices at

maturityBANKR

F P

LATF

OR

M

10. Payment of

financed invoices

at maturity

4. Approved Invoices

. 7. A

vaila

ble

Fi

nan

cin

g

5. Approved Invoices

Supply Chain Finance (SCF) Reverse Factoring

101

FACTOR PAYS

SUPPLIER

IMMEDIATELY

RETAILER

FACTORS

INVOICES

GOODS

INVOICE

The deal is based entirely on the credit-worthiness of the retailer

Strong credit from established company

SME is able to get paid as soon as they deliver. Reduces need for direct SME lending.


What we just discussed.Transaction Flow:

1. Buyer purchasing department purchases goods or services from

a Supplier under a standard purchase contract.

2. Supplier ships goods/render services and sends invoice to Buyer.

3. Buyer legally acknowledges (unconditional) obligation to pay

the paying agent (bank).

4. Supplier and the paying agent (bank) exchange

notification/payment request (via electronic platform).

5. Paying agent (bank) sends Supplier discounted proceeds (100%

of invoice face value minus discount fee) of their receivable.

6. Buyer sends payment to paying agent (the bank) at maturity.

Supply Chain Finance (SCF)Reverse factoring, or approved payables finance, allows Supplier to

receive early payment with a discount, on an invoice due to be paid

by Buyer.

Buyer approves the invoice for payment and arranges for early

payment by means of finance raised from a lender, who relies on the

creditworthiness of the Buyer without recourse to the Supplier.

The lender charges a discounting fee to the Supplier (cost of early

pay) lower than what it would normally cost them for financing

receivables.

The arbitrage opportunity on the difference of cost of capital

between large buying organizations and their smaller suppliers makes

these vehicles popular for organizations that may not want to use

their own capital to fund trade payables.

A win-win for Supplier and Buyer


Why is reverse factoring important?

• Suppliers have a difficult relationship with many corporate Buyers

as they dictate their payment terms. Suppliers also do not want

to wait a long time to be funded as they are usually growing

businesses with high capital expenditure costs. Conversely,

suppliers understand the huge opportunity that is presented to

them when faced with a purchase contract from one of these

large entities.

• Reverse factoring started in the car industry, as it allowed car

companies to work more efficiently with their smaller supply

companies. It also assists in industries where payment delays are

the main fear or roadblock to business.


Key advantages of reverse factoring

• The liability of the funder is concentrated on a large credit

worthy company

• It means that a funder does not have to worry about fraudulent

invoices

• There is clarity for all parties on knowing when payment will be

received; so no long or unnecessary delays

• It limits any disputes as both sides have agreed the invoice

• Reduces supplier cash flow demands and management of

invoices

• It is a validated regime, so as soon as both parties have agreed

to an invoice – the supplier is protected in a later non-payment

event


• A funder only has one party to collect payment from – which is

usually a large corporate

• Close relationships are created between buyers and groups of

suppliers; allowing new companies to work with large corporates

• There is less administration and chasing for payment

• The agreed rate in relation to the whole invoice is advanced,

compared to in a standard discounting scenario where there is a

percentage advance rate with the collecting of a further sum on

payment

• Liability and risk is assumed by the (usually) larger buying

company, so the rate of interest is lower


Benefits

• A simple system set up and there are lower costs involved to the

supplier. The reason is due to the funder taking credit risk on the

large corporate compared to the small supplier. The financier

behind a scheme may also charge the supplier a couple of percent

of their funding line, to join the reverse factoring scheme.

• Provide a line of finance to companies that was previously

inaccessible. Growing suppliers are able to receive funding

quicker, so assisting with their growth and avoiding any potential

insolvency situation. It also important to note that reverse

factoring less expensive than traditional factoring arrangements.


• Works where a funder sits between a company and its suppliers;

where there is a commitment to fund the company’s invoices

from suppliers at a faster rate than provided by a company; in

substitution for a discount.

• Works on the basis that a business receives finance on their

receivables. Conversely, reverse factoring (or supply chain

financing) is a solution where the buyer assists his suppliers by

financing their receivables using a more flexible method and at a

lower interest rate than would be offered. As a proportion of the

market; reverse factoring is less than 5% of the factoring market.

• Beneficial relationship as everyone in the chain understands the

necessity of the funder and as the buyer is assisting the supplier

it can hopefully mean a longer term and more beneficial long-

term relationship.


Benefits to Buyer

• Buyer can have longer payment terms with the

suppliers without having to negotiate any other

consideration such as prices (extension of Daily

Payables Outstanding-DPO).

• Trade payables increase so the buyer experiences

efficiency in daily operations. This further results in

working capital optimization for the buyer.


• Buyers can also take benefits of cash discount

while still paying for the invoice at invoice

maturity date. This requires a pre-arrangement

with the lender.

• An off-balance sheet finance option, the overall

balance sheet of the buyer also looks good with

better ratios of trade payables turnover, days

payables outstanding, working capital turnover,

etc. This helps in raising other sources of finance at

better rates.


Benefits to Supplier

• Receive payments for 100%of invoice value, less discount

fees

• Reduce Daily Sales Outstanding (DSO)

• Suppliers can get faster access to cash at advantageous

rates. This also results in faster cash conversion

cycle from delivery to cash

• Similar to the buyer’s advantage, the overall balance

sheet of the suppliers also looks good and they can get

future finance at better rates.

https://efinancemanagement.com/working-capital-financing/cash-conversion-cycle


• Opportunity to discount receivables at a better rate

than other trade finance options by leveraging Buyer

credit

• Early cash without pledging other tangible

collaterals, with the privileges for insurance against

default of the Buyer without extra costs

• Supplier, with credit challenge, gains access to

credit from a financial institution for as long as it

sells products or services to a credit worthy Buyer,

with a prerequisite of undisputed sales and pre

approved invoices


Benefits to Lenders

• Interest income and fee generation

• Bulk approach of new clients with potential not

only for further lending business with a wider

spectrum of debtors, but also for cross-

fertilization with other departments of the

banking group

• Valuable hook product for capturing the Buyer’s

main transaction account, since all its payments

to Suppliers will be effected through this account


Operations


Summary of Operational and back office functions

Buyer Application, Evaluation, Documentation Process

Supplier Evaluation and Approval Process

Legal Agreements Process

Buyer/Supplier/Bank/Platform

Bank and Buyer Program and Platform Training Process

Bank and Supplier Program and Platform Training

Process

Receivables Posting and Approval Process


Transaction Completion and Funding Process

Receivables Portfolio Management Process

Payment Application Process

Identify Business Intelligence requirements for the

program

Develop plans for short and long term improvement

(both tech and non-tech)

Identify and develop improvements to product,

program, platform and operational efficiencies


Identify and resolve both external & internal

problems, issues, concerns, ensuring zero

interruptions

Ongoing communications with Buyers/Suppliers

Coordination of efforts with Legal in collections and

workout situations in case of default


Buyer Approval Process

Approval of Buyer is a comprehensive due diligence and

a risk process which includes the evaluation and

assessment of the following information. The Buyer will

have to provide and assist in confirming the following

information:

1. Assessment of the quality of the financial package

2. Ensuring the validity of the presentation

3. Financials spreading

4. Assessment of financial condition

5. Establishment and subsequent review of the risk

factors.

Supply Chain Finance (SCF)6. Material differences discussion of the financials, if

applicable.

7. SIC code and industry validation.

8. Comprehensive check of Public Records, and other

evaluation.

9. Compliance, KYC, OFAC

10.Internal risk rating and financial ratios. (DBJ’s current

process will suffice)

11.Buyer orientation and review of Rules & Procedures of

the program. Legal business name and any trade or DBA

name(s). Other currently used names (such as the

Buyer’s DBA name) that the Buyer may use to be

identified


12.Main business address, email address, phone number;

website, TAX ID number (or similar, if available)

13.Stock symbol and indication if any public debt exists

(if applicable)

14.Buyer network ID/ payment portal information (if

applicable)

15.Date the Buyer relationship began with the Supplier

16.Contact name, business telephone number, and email

address of the Buyer authorized accounts payable

contact person


17.Reference ID number that the Buyer will/ may assign

to the Supplier

18.Existing payment terms between the Buyer and

Supplier including the time period in which remittances

are due, and any agreed upon discounts, allowances,

rebates and offsets

19.Ensuring that there is no contra relationship

20.Historical purchase order and invoice history with their

respective proof of payment between the Buyer and

Supplier (at least for 6-9 months)


Supplier Approval Process

Supplier approval process must be conducted prior to

onboarding and funding. The process primarily pertains to

KYC/AML, and does not require a detailed (in depth)

diligent procedure since. The process being:

1. Main business address, email address, phone number;

website, Tax ID number

2. Legal business name and any trade or DBA name(s)

3. SIC code and industry validation


4. Comprehensive check of Public Records, and

other evaluation.

5. Compliance, KYC, AML, OFAC

6. Supplier profile set up.

7. Supplier orientation and review of Rules &

Procedures of the program. Buyer and Supplier

On-Boarding Process


Onboarding Process

Onboarding is the process to take on new clients. It

explains how the product, the platform, the value of the

solution, and the ways it work. It sets expectations of all

the parties involved.

The length of time it takes to completely onboard a client

varies depending on the complexity. For Software-as-a-

Service (SaaS) web based/cloud based platforms and

integration practices, the process from first contact to

fully functional may take up to 8 to 12 weeks.


The five essential onboarding “must-dos” are:

1. Outline the actions required to achieve business

outcomes

2. Map onboarding milestones

3. Share the journey map and milestones

4. Data-driven monitoring of key milestones

5. Proactively managing exceptions


Buyer Onboarding:

As platform service administrator and funder, the Buyer

on boarding will entail:

a. Import master data: represents the business objects

that contain the most valuable, agreed upon

information shared across an organization. Example of

master data contain information about Buyer,

products, employees, materials, suppliers, and other

pertinent details to the objective. Buyer profile set up

b. Administer programs: Supplier groups, early payment

rules, fee calculations, terms


c. Schedule tasks: interfaces with back office, pre-

maturity reports

d. Configure / Access reports and dashboards

e. Import invoice files in user-defined or payment

format

f. Submit changes in Supplier master data

g. Configure discounting rules

h. Configure / Access reporting & Dashboards

i. Export invoice updates to ERP


Supplier Onboarding

The below listed process is similar with respective role

changes:

a.Import Supplier master data & Invoices

b.Confirmation and acceptance of invitation and data

c.Administer programs: early payment rules, fees

calculation, terms

d.Schedule tasks: interfaces with back office (required

only where POs (purchase orders) and invoices are being

sent electronically), pre-maturity reports


e. Settle invoices

f. Configure / Access reports and dashboards

g. Invoice info (status), including invoices not approved

yet

h. Early & Maturity payment history, with invoice/credit

note detail

i. Schedule of next payments

j. Early payment submission

k. Autopay activation

l. Supplier statement: last loaded invoices, available

early payment, last early payment

SCF / Reverse Factoring Flows

Goods

Invoice

LENDER

SELLER(SME)

BUYER(Anchor)

Fin

ancin

g

Pays

Invoices

1. Anchor Buyer creates purchase

order to buy goods from SME

Seller

2. SME Seller delivers goods to

Buyer

3. SME Seller issues invoice to

Buyer

4. Buyer sends invoices,

confirmation and approval to

Lender/ Platform

5. Seller asks Lender/ Platform for

discount facility

6. Lender/Platform provides

discounted finance

7. Buyer pays invoice to Lender/

Platform

1

2

5

6

4

7SCF Platform

Purchase Order

3

SCF / Reverse Factoring Flows - Roles

FACTORSELLER BUYER

• Can be

• Bank

• Non-Bank

• FinTech

• Also called “Factoring

Provider”

• Purchases receivable

from Seller

• Can be

• Manufacturer

• Farmer

• Producer

• Service Provider


• Also called “Client”

• Is originally owed payment

from the Buyer for product

or services purchased

(Creation of Receivables)

• Can be

• Distributor

• Retailer


• Government

• Also called “Customer” or

“Debtor”

• Originally owes payment to

the Seller for product or

services purchased


Goods

Invoice

LENDER

SELLER(SME)

BUYER(Anchor)

Fin

ancin

g

Pays

Invoices



Seller


Buyer


Buyer



Lender/ Platform

5. Seller asks Lender/ Platform for

discount facility


discounted finance


Platform

1

2

5

6

4

7SCF Platform

Purchase Order

3


Goods

Invoice

LENDER

SELLER(SME)

BUYER(Anchor)

Fin

ancin

g

Pays

Invoices



Seller


Buyer


Buyer



Lender/ Platform

5. Seller asks Lender/Platform for

discount facility


discounted finance


Platform

1

2

5

6

4

7SCF Platform

Purchase Order

3

Factoring Versus Reverse Factoring

A) Traditional Factoring

Seller

Buyer 1

Buyer 2

Buyer 3

Factor

B) Reverse Factoring

Anchor BuyerCustomer

Supplier 1

Supplier 2

Supplier 3

Lender/Factor

Factoring

(no anchor needed)

Reverse Factoring

(requires an Anchor)

Advance Rate 80-90% 100% (less fees)

Security Short term AR None – relies on Anchor ability to pay

– Purchased Invoice

Fee payer Supplier who takes out facility Anchor’s Suppliers

Operations Invoices submitted and approved on

individual basis

Buyer approved, Supplier initiated,

discretionary

Arbitrage Savings None Anchor can reduce COGS or increase

payable days

Structure True sale of receivables but

ultimately a secured loan

True sale, off balance sheet finance

for both Anchor and Suppliers

Recourse? Recourse and non-recourse Non-recourse

Collections Lender Lender via automated platform

Factoring Versus Reverse Factoring


Reverse Factoring Platform

1. Multibank

Enables participation from multiple funding sources

Alleviates credit exposure issues, reduces counterparty

risk

Flexibility for buyer to choose banks per region

2. Visibility

Centralized workflow: Buyer, Supplier, Bank

Provides real-time visibility to invoices approved for

payment by Buyer to Suppliers and Banks

3. Ease of Use

As easy to work with multiple Banks as with one Bank

Onboarding of Suppliers


4. Integrates with Treasury

Cash forecasts to optimize working capital decision

making

Payments of financed and non financed invoices from

one platform

5. Integrated SCF Solution

Administer a global Payable financing solution on one

integrated platform

6. Scalable

Improve productivity so that program can expand (but

team doesn’t have to)

Bank connections ERP Integration

Global Reach Web-based


Accounts Payable Turnover Ratio

Example

XYZ Corp

Year Ended Dec

31, XXXX

BN$

Annual Purchases on Credit $12,000,000

Returns (Assuming 8%) $0

Accounts Payable, Beginning of Year $1,500,000

Accounts Payable, End of Year $2,400,000

Payable Turnover Ratio 6.15

Paybale Turnover Ratio

= Net Credit Purchases / Net Acoounts Payble

Payable Turnover in Days 59.31 Payable turnover in days = 365 / Payable turnover ratio


Line of Credit $2,000,000.00

Discount fee per 60 days 3.50%

Funds disbursed to Suppliers $1,930,000.00

Payment received from ABC Co. in 60 days $2,000,000.00

Discount fees earned for 60 days $70,000.00

Annualized line of credit $12,000,000.00

Annualized Discount fees 21.00%

Annualized funds disbursed to Suppliers $11,580,000.00

Annualized fee income $420,000.00

Assumptions:

100% Line utilization

100% Suppliers

100% Trade Payables


Sample Case

Citibank

https://www.citibank.com/tts/sa/videos/supply-chain-finance-case-study.html





Asset Based Lending

146

Asset Based Lending (ABL)

SME Financing

Financial Leasing


Lending

Supply Chain

Finance

Inventory Finance

147

Asset Based Lending Characteristics

• Finances a company based on its assets (Accounts Receivable(A/R) and Inventory)

instead of available Real Estate as collateral.

• Provides more financing than cash flow lending, based on value of movable assets.

• Gives company advances based on likelihood of converting assets to cash.

• Requires that all sale proceeds reach the collection account of financing company.

• Needs monitoring of Collateral and Borrowing Levels.

• Allows low Lender losses, since all borrowing is collateralized by assets, and if

issues arise, the Lender can stop additional fundings and collect proceeds, exiting

the loan in an orderly way.

148

Asset Based Lending Flows

Goods

Invoice

Payment

LENDER

SELLER(Client)

Obligor/Account Debtor(Customer)

1. Client provides goods /services to Customer

2. Client sends invoice to customer

3. Client provides Borrowing Base (BB) and support documentation to Lender

4. Lender advances based on “Collateral Availability”

5. Customer pays Client

6. Collections go to Lender to reduce Loan

1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

149

Asset Based Lending - Roles

SELLER LENDER Obligor/Account Debtor

• Can be

• Bank

• Non-Bank

• FinTech

• Also called “ABL Lender”

• Finances Inventory and

Accounts Receivables

• Has control over cash

account where

Obligor/Account Debtors

pay Seller - “Cash

Dominion”

• Can be

• Large or Medium

Business

• Nearly any industry

with inventory and

accounts receivables

• Also called “Client” or

“Borrower”

• Provides ongoing, regular

information to Lender

• Can be

• Any sized business

• Characteristics drive

‘funds availability’ to

Seller

• Also called “Customer”

150


Goods

Invoice

Payment

LENDER

SELLER(Client)








1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

151


Goods

Invoice

Payment

LENDER

SELLER(Client)








1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

152


Goods

Invoice

Payment

LENDER

SELLER(Client)








1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

153


Goods

Invoice

Payment

LENDER

SELLER(Client)








1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

154


Goods

Invoice

Payment

LENDER

SELLER(Client)








1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

155


Goods

Invoice

Payment

LENDER

SELLER(Client)








1

2

3

4

5

6

Client Bank

Account

Controlled by

Lender

156

ABL Secured Lines of Credit

157

Purchase of

Raw Materials

Transformation

ProcessSale of the

Product

Payment

Advance Payment

Line

of

Credit

Value of the Collateral = Advance Available

Greater Risk =

Less advance

Less Risk =

Greater Advance

The analysis of the availability under a secured line of credit equals the

total of the inventory and accounts receivables, minus assets that are

considered ineligible.

158


SMEs Assets

Source: IFC Diagnostic Reports

• Generally, Banks require Real

Property as Collateral to grant

SME loans

• SME’s assets are generally

concentrated in operating

assets used in their production

cycle

159


• Asset based Lending (“ABL” ) is a revolving credit line for SMEs to

obtain financing using their operating assets (movables) as collateral.

• Credit availability is based on the quantity and quality of the SME’s

operating assets:

• Inventory

• Accounts receivable

• Credit availability follows the SME’s operation

• Provides funds during the manufacturing and collection cycles

• The Credit Line is paid with Sale Proceeds

• Credit Line is guaranteed by the productive assets and the proceeds of

the collection of the SME’s sales.

160


• There is a close relationship between the Lender and the SME through

the monitoring process.

• Credit lines can be for 1 year or longer.

• The ABL reduces Lender’s risk, since the line draw downs are related to

the SME’s Inventory and Accounts Receivable, based on a formula that

dictates the credit availability given the available collateral.

• Provided by specialized Lender.

161

Goals – Achieved Today in Many Economies

• Less than 1% loss rate

• 80% to 90% of the invoice value advanced

• 25% to 50% of inventory value advanced

• Controls the ability to report on the collateral

• Very significant proportion of commercial lending

• Why such low losses?

• Collateral that has a known liquidation value

• Monitoring the collateral – constantly

• Controlling cash – revolving loan

• Securing priority rights to the collateral

162

Asset Based Lending Revolving Line Operation

163

Factoring and Asset Based Lending Comparisons

Asset Based Lending Factoring

• Grants Financing during the

Manufacturing and Collection Cycles

• Finances Finished Goods held in Stock

• Starts from 100% of Inventory, then

reduced by ineligibles

• Starts from 100% of Accounts

Receivable, then reduced by ineligibles

• Requires that all sale proceeds are

deposited in a controlled account, in

which Lender has control rights

• Gives Liquidity during the Collection

Cycle (Factoring), acquiring A/Rs

• Grants funds only when an Invoice has

been created and product delivered

• Certain debtors are selected, and A/R

purchased only from them, subject to

credit limits

• Can be direct collection (Non recourse

Factoring) or delegated collection

164

Which Assets can be Financed by ABL?

• ABL Basic Goal is that the Lender can be paid back from collateral liquidation at any time

• Asset Based Lending requires a LIQUIDATION VALUE analysis performed for the main

productive assets of the SME.

1. Inventory

2. Accounts Receivable

• Each type of asset is assigned an advance percentage, which

depends on the time and likelihood of the asset to convert in cash.

Lower Advance % Higher Advance %

• Availability calculation starts from Total Inventory and Accounts Receivable, then

certain assets are excluded based on pre-defined parameters

Accounts

Receivable

CollectionManufacturing Process and Time

Raw

Material

Purchase

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Examples of Eligible Collateral

Paper

• Accounts receivables from credit worthy customers

• Warehouse receipts from a secure warehouse

• Intellectual property

Physical

• Raw materials for manufacturing industry, textiles, metals, wood, chemicals, etc.

• Raw materials for agriculture – fertilizers etc.

• Finished goods

• Crops – providing they have a reasonable shelf life

• Oil and chemicals

• Household goods

Equipment

• Agricultural, mining, industrial and garment industry machinery

• Transportation equipment and motor vehicles

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Examples of Ineligible Collateral

Receivables

• Delinquent or past due accounts (>90 days old)

• 2 days old – but from the same company that also owes on an invoice that is over 90 days old (Cross Aged)

• Due from the owner’s cousin, or a firm under the same ownership (Affiliated Accounts)

• Overseas debtor (Debtor located where legal rights not recognized

• Suppliers (Contra)

Inventory

• On a truck, somewhere..(Unsecure locations)

• Half finished by uniquely skilled artisans

• Meat, or any fresh produce

• Customer Specific

• Licensed

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Evaluation of Accounts Receivable

• Who is the Receivable from?

• What are the terms?

• Is the sale complete?

• Is there the possibility of dispute of the Receivable?

• How long is the collection cycle (A/R turnover)?

• Concentration Percentage of Account Debtor

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Evaluation of Inventory

• What makes up the Inventory?

• How is it valued?

• Is there a ready market for the Inventory?

• What must be done to prepare Inventory for sale?

• How long is Inventory sales process?

• Where is the Inventory located? Accessibility?

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Key Monitoring Components

• Borrowing base certificate• The key document on which the customer certifies how much collateral is available

and eligible for borrowing.

• The Borrowing Base certificate is usually updated frequently

• Depends on how often advances are made

• At least weekly

• Advance rate• The percentage of the collateral value that will be advanced.

• There will be a different advance rate for receivables and each category of inventory.

• Availability• The amount of the loan that can still be advanced, taking into account the current

collateral and the credit limit.

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Establishing Advance Rates

Accounts Receivables

• Accounts Receivable Advance Rates typically range from 75% to 90%.

• The higher the quality of Accounts, the higher the advance rate.

• A general formula for estimating A/R advance rates = 100% minus (past due percentage + 10%) or 100% minus (dilution percentage + 10%).

Inventory

• Inventory Advance Rates typically are much less than against accounts receivable. Typical ranges are 25-50%.

• The more liquid the Inventory the higher the Advance Rate.

• The more commodity-like the Inventory, the higher the Advance Rate.

• The more control a lender may exercise over the inventory, the higher the Advance Rate.

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ABL Availability Calculation

1. Inventory

Total Inventory

- Work in Process

Obsolete Inventory

Inventory subject to Copyright

= Eligible Inventory

x Advance Rate (between 40 and 50%)

= $ Available for Inventory

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2. Accounts Receivable (A/Rs)

Total Accounts Receivable

= $ Available from Accounts Receivable

-A/Rs > 90 days

Past due A/Rs

A/Rs when there are A/Ps to the same company

High Concentration Reserves for A/Rs

Cross Balanced A/Rs

= Eligible Accounts Receivable

x Advance Rate (between 75 and 85%)

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Required Monitoring for Asset Based Lending

• One of the main characteristics of ABL is the constant monitoring and comparison

between Available Collateral and Credit Line Balance

• ABL encourages borrower to reinvest earnings: If there is more collateral, the availability

of the credit line increases

• ABL reduces a lender’s risk since:

• Each Credit Line Funding is based on formula based on the SME’s available collateral

• The lender can modify the advance rates or stop funding, upon a deterioration in the

Financial or Collateral situation of the Borrower

• ABL Revolving Credit Line operation and monitoring is done though specialized software.

• Borrower sends the Collateral information (Borrowing Base Certificate)

• Lender controls Credit Line parameters through the system, which sends alerts

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Required Monitoring for Asset Based Lending

Initially

• Field Audit for Collateral Analysis and Valuation

• Accuracy of Ledger amounts

• First Calculation of Borrowing Base (Credit Availability)

Every Draw Down

• Inventory and A/R levels

• New A/R supporting Info

• Updated Borrowing Base calculation

• Outstanding +/- changes vs Past Balance + New Funding

Monthly

• A/R Aging

• Inventory Breakdown

• Financial Statements (Balance and Income Statement)

Every 3 – 6 Months

• New Field Audit

• Accuracy of Ledger Amounts

• Differences

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Risk Mitigators in Asset Based Lending

• Financial Analysis based on likelihood to

convert the Inventory and Accounts

Receivable in Cash.

• Differentiated advance % given on Inventory

(40-50%) and Accounts Receivable (75-85%).

Credit Analysis Asset Based Lending Closing

• Borrower grants as collateral present and future

Inventory and Accounts Receivable to Lender and

a controlled account is created to receive the

collection proceeds from the SME sales.

• Lender provides a Revolving Credit Line to SME.

• Borrower sends a Borrowing Request with

updated calculation of Credit Availability,

based on new Inventory and A/R levels

multiplied by the advance percentage.

• Credit Balance + Requested Amount < New

Availability.

• Lender receives request, verifies and wires

money to SME.

Credit Availability Credit Line Payment

• A/R debtors are instructed to pay in the

controlled account.

• Account monies are used to pay down credit

line, reducing outstanding balance thus creating

credit availability on revolving line.

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Requirements for ABL to be Attractive to Banks

1) Increase Bank’s Credit Outstanding

• Ideal for Banks that have an SME portfolio with good payment history that

need more funds, and

• There is no more Real Property to grant as collateral

• SMEs with mid to high borrowings

• Bank’s prior experience in Factoring or Inventory Loans is a plus

2) Close Monitoring enabling exit of credit if borrower deteriorates:

• Banks with Robust Collection Systems

• Implement a Product Operation and Monitoring Function, establish or

outsource Field Audit Capability

• Legal system that provides Lender with Real and Enforceable Guaranty

against the Controlled Account Deposits, and also current and future

Inventory and Accounts Receivable

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CASE STUDIES

Case 1Sauve Fashions is a garment manufacturing business. The

nature of this business tends to be seasonal as fashion

lines follow the four seasons of the year. They receives

large orders from various national retailers several times a

year. Given the cyclical nature of this industry, the

customer requires a working capital solution to cover its

sharp rise in additional labor costs and raw materials

costs.

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It is well-documented that banks have dramatically

reduced their lending to small-to-medium enterprises

(SMEs). Not only would the typical bank not extend this

company a secured line to finance its large orders, the

length of time between an initial bank loan application

and final funding would not be conducive to this

circumstance as large retailers demand prompt delivery or

they have the right to either refuse the order or receive a

significant discount.

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This customer utilizes a factoring facility to finance its

working capital needs. During periods of high order

volume, it factors its accounts receivables to fund its

additional labor and input costs. By converting its

receivables into immediate cash, the company can

confidently accept large orders and seek additional

growth opportunities. While the customer does pay a

factoring fees to factor its receivables, the resulting cash

flow, profits and growth opportunities more than

outweigh the financing costs.

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Without a factoring facility, the company would have to

refuse sizeable orders. Accordingly, Obligor/Account

Debtors would seek alternative suppliers.

This example highlights how factoring improves a

company’s cash flow profile, profitability and funds SMEs

which are an economy’s engine of growth.

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ABC Company is a manufacturer of fine lawnmower parts. Its

customer base is made up of Toro, Honda, and other domestic

producers of lawn care equipment. The company is somewhat

seasonal, and as a result, traditionally offers extended terms

to its customer base in order to level its production schedule.

Typically the company will ship a great deal of its products

(about 70%) in January and early February, with payment due

July 15. All sales are FOB Shipping Point. Majority of ABC’s

customers pick up in their trucks or provide common carrier.

Each shipment is evidenced by a bill of lading signed by the

shipper. According to policy, no invoice can be issued without

a bill of lading as backup.

Case 2

Understand accounts receivable agings and concentrations and be able to evaluate

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Case 3

BCD Coatings Group is a distributor for and installer of custom

textured paint and wall coverings to the high-end home

market. Since its founding in 1993, the company has

established a large and highly profitable niche in the extremely

high end BN$5,000,000 plus home market in Kuala Belait,

Tutong, and Temburong. The company has been featured in

Architectural Digest for its work, and prior clients include high

end developers. Terms are 100% payment due on job

completion. Average time for completion of a job is 30 days.

The Company often is referred by and works in tandem with

some of the country’s most renowned architecture firms. Many

jobs are a part of a larger home renovation or makeover.

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Case 4

Big Time Outdoors is a manufacturer of hunting and sporting

clothes under the Mossy Oak and Real Tree Brands. Mossy Oak

and Real Tree are premier providers of camouflage pattern

material. Each company offers to a highly select group of

manufacturers the right to produce various products under a

licensing and royalty arrangement. The selection process for

inclusion in the approved producer base is highly competitive,

and therefore highly valuable. While the licensing

arrangement is highly selective, approved producers are

permitted to sell their product anywhere. Together, Real Tree

and Mossy Oak control a large majority (over 90%) of the

market

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In order to be a serious competitor in this industry, the

ability to produce these products is imperative. Big Time

Outdoors is fortunate that it has an exclusive license to

produce Big and Tall camouflage clothing. No other

manufacturer in the world can produce or has an

inventory of these products, which include hunting wear

from 3X to 8X. It is the sole source for Big and Tall shops

throughout Brunei.

Understand inventory components, performance, slow moving and obsolete and

be able to evaluate

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Case 5Tech Air Source, Inc. is a manufacturer of circuit boards and

related computer hardware items which are used in the

repair, expansion, and upgrade of Brunei Civil Aviation

Authority control towers throughout the world. It sells its

product through a network of distributors in the Africa,

Middle East and Europe. The lead time for production of

circuit boards can be as long as two years, and is often

dependent on funding limitations of developing countries.

The Brunei Civil Aviation Authority has adopted a worldwide

standard for computer hardware and equipment. Because of

lack of wealth and technological capability, the standard has

not changed in over twenty years.

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As a result, Tech Air manufactures its circuit board using

computer chips of circa 1981. Over the years, it has

been forced to purchase all of these older legacy chips as

they come on the market. Last year, Tech Air’s sales

were BN$4,000,000. It has inventory of these computer

chips on hand of approximately BN$7,000,000.

Understand inventory components, performance, slow moving and obsolete and

be able to evaluate

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Case 6ABC Service LLC

ABC is a provider of transportation, assembly and

messenger services for various companies. They will not

only deliver furniture, but will also assemble it on behalf

of well known stores.

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Assets

192

Liabilities

193

Income statement

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Conclusion

Excellent customer base and accounts receivable performance

Good books and records as evidenced at quarterly field

examinations

Satisfactory telephone verifications

Flexible terms as evidenced by term loan extended and periodic

overadvances from time to time

Unlimited personal guarantees of all owners

Deficit Net Worth due to the lack of profit retention by owners

No financial covenants

No CPA prepared financial statements

No requirement for subordinated officer and family member debt

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“Dream” Food Corp Case Case 7

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Key Success Factors -Summary

1. Company had a Buying Process which included cross

functional stakeholders

2. Company had Specific and Achievable Program

Objectives with Executive Support

3. Opportunity identified in the Spend Assessment

Supported Objectives

4. Company constructed a clear and well thought out

Program Design

5. Through Effective program design, Supplier

Onboarding was exceptionally successful.

Thank You!

Connect on LinkedIn

Imtiaz Ahmad: [email protected]

+1 972-786-4787

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