Understanding Receivable Financing Pricing and Rates is Not Impossible!

“Misunderstanding all you see.” Those are lyrics from the Beatles’ “Strawberry Fields,” and talk about being a bit appropriate for the confusion around receivable financing and invoice discounting rates in Canada.

So, talk about confusing … let’s try and clear up some real basics around receivable finance in Canada -mostly along the lines of how it works and how it is priced. Clients are always providing their version of what they think they are getting, but the reality is often far from that.

A/R finance is used by thousands of firms in Canada to address cash flow shortages when in fact more traditional financing simply doesn’t make sense or can’t be attained.

A good way to clear up some of the confusion around this method of business finance in Canada is to address it head on, which is simply to say that this finance mechanism isn’t financing per se, it’s simply the sale of one of your assets at a discounted rate. So from that perspective, even we own up to being guilty sometimes around the terminology!

Another way of looking at our issue to frankly address what might be perceived or real drawbacks or negatives around A/R financing. The discount rate used on receivables when you sell them, in Canada, ranges anywhere from 1 percent to 5 percent. To be fair, the average discount rate tends to be in the 2 percent range.

Invoice discounting rates make the most sense when they are used to take advantages of opportunities for growth and higher profits and sales via asset turnover.

Part of the reason A/R finance is viewed as confusing by many is that it’s essentially part of an unregulated industry. Clearly our banks are regulated and you know what you get (when you can get it!)

So what does that all mean to Canadian business owners and financial managers? Simply four words. Pick a solid partner! Or an adviser.

Where invoice discount financing gets confusing is in the terms/contracts and the rates.

So how do you address that pricing in terms of benefits? Several factors have to be taken into consideration. They are the quality and age of your receivable portfolio, the “opportunity cost” of what you can do with additional cash flow and the actual cost of carrying your receivables and inventory as opposed to monetizing them more quickly via a receivable financing strategy.

As we have said in the past, carrying receivables anywhere from 60-90 days can easily cost you anywhere from 10 percent to 20 percent when you factor in days to pay your firm, admin costs, lost opportunities, your current financing costs, etc.

So why do Canadian business owners and their finance staff stumble on the issue of receivable finance?It’s partly, as we have shown, due to their inability to overlook the total pictures in the areas we have demonstrated above.

Invoice discounting rates makes the most sense when you look at opportunity cost. If you finance your receivables as you generate them, you lower the balance sheet investment and reduce your day’s sales outstanding.

A quick example – if your annual sales are $1.2 million and your daily sales are $3,300 per day, for example, you could add $10,000 to cash flow by a three-day reduction in DSO. A 30-day reduction adds $100,000 to cash flow!

Charges or costs for a $100,000 per month facility equate to a $2,000 per month cost if you are turning your A/R promptly. So, confusing. We hope not, although we’re the first to admit it takes a bit of time.

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