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Accounts Receivable Financing, An Option for Businesses in Times of COVID-19

While good liquidity is a vital weapon in the face of the crisis, access to working capital is becoming increasingly complex; accounts receivable financing stands out as a solution to this challenge.

This article was translated from our Spanish edition using AI technologies. Errors may exist due to this process. Opinions expressed by Entrepreneur contributors are their own.

By: Edmundo Montaño, CEO of Drip Capital México .

William Iven vía Unsplash
  • How can companies improve their finances? The immediate answer is financing. However, another challenge arises.

Despite the fact that the economic reopening has started, the uncertainty, as well as the scope and duration of the crisis, are still a question for companies in the country and the world.

Given this, consultants and specialists emphasize that the best way to prepare to face it is to understand what its risks and vulnerability are from an operational and financial point of view. With this in mind, an effective level of liquidity and strategies related to cash flow management stand out as the main advice from the experts.

But, while, in the last quarter of 2020, investment, consumption and exports in Mexico report the strongest falls in the records of the National Institute of Statistics and Geography (Inegi) , the natural question is, How can companies improve their finances?

The immediate answer is financing. However, another challenge arises.

Photo: Micheile Henderson via Unsplash

The conditions for both access and loan application during the last quarters of the year have also been significantly affected : not only is it that companies demand fewer credits due to the concern of not being able to meet the obligation of a debt, but banks and financial institutions have become stricter in the conditions and standards of approval.

This does not mean that financing is completely ruled out, as there are still other ways to finance your operations without acquiring more debt. Reduce inventory days, renegotiate payment terms with customers and suppliers, are some of the options, but one of the most prominent for the possibilities it offers is the financing of accounts receivable.

How does accounts receivable financing work?

As its name says, it is a way to finance your operation by resorting to your accounts receivable, that is, payments of invoices of which you have already made a sale, but are in a credit term that you offered to your customers (usually 60 to 90 days).

While credits usually ask for collateral as collateral and imply financial leverage (in other words, debt), this scheme is a commercial transaction, through which you "sell" your receivables to a third party (called factor, which consists of a company specialized in financing, or development banking institutions), in this way you receive the cash agreed in advance.

Also known as invoice discounting or factoring, this type of financing has been considered an attractive option to finance the operation of Mexican companies by organizations such as the Inter-American Development Bank (IDB Invest).

This is how an accounts receivable financing transaction usually works:

Image: Drip Capital.

Another of its great advantages is that it has minimal tax and accounting implications: the main difference, in terms of tax or billing documents, will be the issuance of payment supplements in accordance with annex 20 of electronic billing .

The working capital you acquire enters directly as cash and is reflected in your assets on your balance sheet, so it is a way to inject liquidity and have a better cash flow.

In terms of costs, the factor usually charges a factoring fee , plus interest. For example, if your company requested financing for an invoice with a value of 50 thousand dollars , you would receive an advance of 40 thousand dollars and the approximate charge, based on the days financed (for this example it will be 60 days) and the credit approval (1.0% for the purposes of this case) the cost would be one thousand dollars.

The following months will still have many challenges for Mexican companies, so prioritize strategies that help them have Healthier balance sheets and easily accessible working capital is a vital weapon in the face of crisis. Financing is a first step to achieve it while we discover what the “new normal” will be like post-pandemic.