A combination of rising borrowing demands and a winding down of emergency Government fiscal packages has resulted in a potential financial cliff edge for UK businesses.
Specialist lenders that offer receivables finance will be a crucial part of the solution to this funding gap and are well equipped to step up to meet this challenge. In doing so, they have an opportunity to optimise their receivables finance products to increase efficiency and create better outcomes for their clients.
One way of achieving this is through “Open Accounting” – a practice that can help lenders provide better lending products for businesses through the transparent sharing of accounting information. As demand for borrowing increases, Open Accounting is becoming less of a nice-to-have and is increasingly an essential component to streamlining business processes as the industry further digitalises and moves away from outdated manual processes.
Open Accounting: automating the creation of shadow ledgers
Traditionally, invoice discounting has been managed based on a bulk collateral position and so the lender only has the total balance of the sales ledger upon which to base its funding. It will operate a trust account for payments of the assigned invoices, which means that the lender controls the cash receipts of the client, but they must also have processes in place to ensure that the sales ledger position they are funding against is correct. Reserves must be calculated and applied in respect to the receivables they believe are less collectable or have increased risk, such as very overdue invoices. As a result, this way of operating can be very labour intensive and creates friction for the client.
In the UK market, some lenders are pulling away from full-service factoring, which is perceived as too costly to the lender however, this hands-on management of the sales ledger mitigates risk as the lender has complete visibility of the receivables and can apply invoice level and debtor level rules. Full disclosure rights allow for communication with the client’s customers and enable the lender to push for payment of invoices and detect any issues that may exist, such as disputes or fresh-air invoices.
Providing invoice discounting secured on a shadow ledger, effectively a replicated copy of what is contained within the client’s accounting system, is a good option for lenders. Shadow ledgers have all the risk management capability of factoring but leave the client to service the ledger and manage its credit control processes. However, getting the data has always been a challenge, but this is where data extraction through Open Accounting can help. Lenders can effectively replicate the client’s sales ledger within their technology platform and thus automate the creation of a shadow ledger. The lender can now provide an invoice discounting facility, with all the controls and risk mitigants that exist for factoring. There is even the added advantage of being able to switch a problematic client from ID to factoring or operate a full collect-out of the ledger should the client become insolvent.
Better lending products
Once the lender has this granular data, it can offer to lend against a more accurate and optimised view of the risk and augment risk management with additional controls such as selective verification of invoices. It can more easily track dilutions such as credit notes, overdue invoices, poor debtor quality and concentration risk. It can also provide a range of value-add products such as credit insurance, outsourced or guided credit control, payables management, and more in-depth data analytics to advise the client.
The increased transparency of Open Accounting gives lenders greater confidence and a clear understanding from the outset that they are dealing with legitimate businesses. This level of clarity is crucial for banks, given that fraud costs the global economy $5 trillion a year – a reality that could discourage lending to businesses on a classic bulk invoice discounting basis.
Finally, Open Accounting holds another major advantage. The tailored and bespoke services it allows lenders to create for their clients helps to build stronger relationships resulting in a ‘stickier’ portfolio with less churn and greater lifetime value. A key factor when considering the effort and cost associated with originating new business.
As crucial for lenders as it is convenient for clients
‘The customer is king’ is an adage increasingly relevant to lending as fintech seeks to disrupt traditional lenders and steal market share. Enhanced customer service is cited by 90% of fintech companies as a decisive competitive advantage, meaning that despite the increased demand for borrowing, lenders must ensure they can provide clients and potential new businesses with attractive and easy to use offerings to stave off competition.
Open accounting is core to this. For those that are still sceptical about data extraction, a shift in mindset is needed to embrace the concept and appreciate the opportunity that has enriched, granular and accurate data can bring.
With government lending packages now being withdrawn, lenders have been placed in a strong position as they are fundamental to further facilitate businesses recovering. A rising tide of demand will not necessarily raise all ships, so lenders need to be equipped with financial services that have a broad appeal and create long term, profitable business going forward.
Article first appeared on: Business Money