Fundtech white paper, e invoicing provides new avenues for credit

E-Invoicing Provides New Avenues for Credit

Trade finance is one of the most stable forms of lending and can become an important profit generator for banks. Electronic Invoice Presentment can help banks promote and expand this business.

E-Invoicing Provides New Avenues for Credit | White Paper 2

Fundtech FSC 2011 | www.fundtech.com | [email protected]

E-invoicing Provides New Avenues for Credit Electronic invoicing enables effective supply chain financing and provides banks with a platform to pursue low-cost, low-risk financing strategies. Executive Summary With credit availability remaining tight following the financial crisis, banks and corporations alike are more attuned to the financing opportunities linked to supply chain transactions. With the visibility and transparency of trade transactions and the link between funding and trade activities, supply chain finance lessens the risk associated with traditional lending. Electronic invoice presentment and payment (EIPP) systems can amplify the many benefits of supply chain finance by automating a process that traditionally has been hampered by paper-based manual methods. By automatically delivering real-time information to banks involved in trading transactions, EIPP makes it possible to automate efficient financing based on current insights into companies’ health. This paper will describe the various methods of supply chain finance and how EIPP can be deployed to magnify their benefits.

Scarce Credit The global financial crisis may be easing, but corporations and financial institutions are still feeling its impact. Concerned about the macroeconomic outlook as well as the impact of Basel III and other regulations, the financial industry continues to maintain a tight rein on credit. In a recent report (“Trends in Lending”, Bank of England. January 2011), the Bank of England reported that the loans made to small and medium-sized businesses declined through 2009 and 2010. A separate survey (“Credit Conditions Survey”, Bank of England, 2010 Q4) further illustrates a steady decline in the amount of credit available to businesses through 2009 and 2010. In a logical reaction to the crunch, corporations are seeking to unearth assets by better managing their cash flows and working capital. “The lack of credit requires more attention to the dynamics of cash,” said Enrico Camerinelli, senior analyst at Aite Group and the author of a recent report on strategies for cash and trade finance. Aberdeen Group quantified the increased focus on optimizing working capital, finding that 83% of 115 surveyed companies cited working capital management as a high priority in 2010, up from 65% in 2008. Aside from credit capacity, firms have reason to be concerned about the health of their suppliers. Since the financial crisis triggered the recession, the number of businesses that annually file for bankruptcy protection has increased 126%, said the research firm Oliver Wyman in a recent report on supply chain finance, citing figures from U.S. Bankruptcy Courts. Oliver Wyman noted the “devastating” effect that a supplier bankruptcy can have on companies, citing increases in the prices of supplies of 10% to 15%, lost customers, and a decline in shareholder value.

“The lack of credit requires more attention to the dynamics of cash” Enrico Camerinell i , Aite Group

E-invoicing Provides New Avenues for Credit | White Paper 3


A Resurgence of Transaction Based Lending The twin pressures of scarce traditional bank credit and concern for supplier health are leading banks and corporations alike to explore financing options that revolve around trading and transaction activity. While these options encompass a wide range of solutions, their common value lies in their ability to bypass traditional lending structures, while providing valuable insight to the health of participants in the supply chain. While traditional lending requires the knowledge and expertise of highly paid loan officers, transaction-based lending or supply chain finance relies on the invoice as a key document in enabling lending. Using the visibility gained through the invoice onto the trade - including the partners involved, the ability of the buyers to pay, and the expected receivables of the suppliers -- banks can make knowledgeable judgments about the creditworthiness of trade participants. Perhaps even more valuable, banks gain visibility into the viability of their customers’ trading partners, giving them the opportunity to forge new credit relationships.

Buyer and Supplier Led Relationships There are a number of ways banks can take advantage of the growing supply chain finance market. In supplier-driven financing, the bank only has a relationship with the supplier. In buyer-driven financing, which is considered more attractive, the bank has a relationship with both the supplier and the buyer. This approach is appealing because the buyer is responsible for managing the suppliers and resolving issues. In addition, buyers tend to be better credit risks than suppliers, lessening funding risk. Supply chain finance is not a new concept. Often it is introduced when buyers want to extend their payment terms and suppliers require funding to cover the cash-flow shortfall. Since its introduction in the 1990s, the method has grown to include a wide variety of permutations. The difference today is that the end of easy credit is taking away the stigma that traditionally has been attached to companies seeking financing outside of standard lending venues. The technique is no longer the province of cash-strapped companies, but the natural outgrowth of an e-commerce-fueled economy. It is not surprising then, that the market for supply chain finance is on an upswing. According to the UK Supply Chain Finance Working Group, the market grew from about 100 million pounds in 2008 to one billion in 2010.

The Growth of Open Account Trading Traditionally, banks were involved in providing letters of credit to suppliers, acting as trusted third parties, vouching for payment on behalf of buyers to the suppliers, should certain pre-defined conditions be satisfied. However, over the years, an increasing amount of trade is conducted on an open account basis as the volume of trade has increased. The diagram above illustrates the demise of letter of credits. Currently about 90% of world trade is on open account. The demise of letters of credits has opened the door to alternative trade financing mechanisms based on the invoice - and on the electronic invoice in particular.

“The (SCF) market grew from about £100 million in 2008 to £1 billion in 2010” UK SCF Working Group



Electronic Invoicing Unleashes Supply Chain Finance A number of areas have proven to be barriers to the adoption of widespread supply chain financing. Many of these barriers are now being eliminated by the growing popularity of open B2B networks:-

• Legal and Compliance Constraints have stymied the full electrification of documents used in support of SCF activities. E-invoicing networks have largely addressed this issue by ensuring the service offered in each participating country is fully complaint with local requirements. There are further market trends to clarify and harmonize country compliance requirements - especially in Europe.

• Document Standards. Historically, there has been a lack of clarity and agreement on document standards for electronic invoicing - and this confusion has held back the market. EIPP vendors now provide services which handle the multitudes of formats in existence, consequently the lack of a single global standard has not been a real practical barrier - but merely a perceived barrier. However, ISO have recently released a global e-invoicing standard based on ISO 20022 format which will in all probability stymie the format debates.

• Manual Business Processes. A class of SCF solutions - like early payment discounts - rely on the fast and efficient processing of trade documents. To be able to approve an invoice for payment within a matter of days requires an automated accounts payables process based on electronic transactions. Furthermore, if the transaction requiring financing results is a high administrative burden, the value of the transaction needs to be of sufficient magnitude to cover the costs. This makes it prohibitively expensive to provide financing on the larger volume of lower value transactions. With the increasing use of fully automated procure-to-pay solutions receiving dematerialized business documents over a B2B network, the whole SCF offering can be fully automated and made available on transactions of much lower value than has been the case.

• Lack of SME Engagement. SMEs (small and medium sized businesses) have the most to gain from SCF arrangements. However, they have not really been involved in SCF initiatives on any significant scale. There are many reasons for this - not least is the highly specific nature and limited utility of conventional SCF portals. One of the key areas of focus within the e-invoicing market is the SME sector. Arguably only banks have the reach to provide e-invoicing services to millions of SMEs in a cost effective manner. Being able to provide financing services integrated into their SME e-invoicing offering greatly enhances the attractiveness of the service for both the SME and the bank.

• Crit ical Mass. Proprietary SCF solutions and portals have struggled to achieve a useful critical mass of suppliers. However, broad based B2B networks are increasing in popularity and utility. A key technological and strategic advance occurring in the marketplace is the fusion of electronic invoice presentment networks with transaction-based lending solutions and services. Currently the number of B2B e-invoices is growing at a cumulative rate of about 35-40% per annum in Europe [Billentis]. With the European Commission championing activities to make electronic invoicing the predominant method of invoicing by 2020, the electronic invoice transaction volumes are likely to grow further in the near future. Billentis predicts that most European member states will have more than 50% of their invoice volumes electronic by 2015 with the overall average across Europe exceeding 50% by 2017.

“As a new delivery model ... SCF requires banks to bring large corporates and SMEs on board through the development of new infrastructure, new value propositions and new sales and marketing strategies” Supply Chain Finance: From Myth to Reality, McKinsey



E-invoicing Support for Supply Chain Finance Structures The increasing prevalence of e-invoicing networks has far reaching implications on the supply chain finance market. For the first time, there will be a critical mass of business transactions dematerialized and available in an electronic form to feed SCF services. Multiple competing SCF vendors will connect to existing massive B2B networks to provide innovative financing services. The following sections look at different supply chain finance instruments and consider how they can be implemented on top of an e-invoicing network, and what benefits are to be gained from the integration.

E-invoicing and Factoring Perhaps the most widely known method is factoring, in which a supplier sells its receivables to a third party factor, often a bank, at a discount in exchange for immediate cash to continue financing its business. The specific steps are as follows:- 1. The factor ‘buys’ the receivables obligation (invoice) from the supplier. 2. The factor advances a part payment to the supplier which is significant fraction of the invoice value. 3. The factor is responsible for collecting the receivables from the buyer. 4. The factor receives full payment for the invoice. 5. Upon receiving payment, the factor pays the remainder of the funds to the supplier, minus its fees. Key benefits of integrating e-invoicing and factoring are:- • Fully automated, straight-through processing for supplier, factor and buyer. • Granular control on factoring arrangement. • E-invoice presentment to buyer with automated support for receivables collections.

(e.g. reminders, e-dunning, direct-debits, etc). • Real time communication of documents and messages. • Improved reconciliation and payment status tracking.



E-invoice Discounting Invoice discounting is similar to factoring. As with factoring, the business obtains cash from its receivables at an early stage - however the supplier is still responsible for collecting the receivables. In effect, the bank allows the business to draw down funds against its outstanding sales invoices, essentially using the invoices as collateral. The bank charges a monthly fee, as well as interest on the amount borrowed against the invoices. It may choose to refuse to lend against any invoices it deems too risky. In addition to receiving all the benefits of factoring, the supplier can minimize disruption to the day-to-day operations of the company. That is because the receivables process proceeds as normal, except that the receivables are used to enable loan facilities. The specific steps are as follows: 1. The supplier sends an invoice to the buyer - but also sends a copy to the bank. 2. The supplier requests a loan based on the future receivables. 3. The bank approves the loan request and immediately makes a facility -- generally a

fraction of the receivables value -- available to the supplier. 4. At some point in the future the supplier receives payment from the buyer. 5. The supplier pays the bank the full value of the receivables to cover the loan. 6. The bank then reimburses the supplier the remainder of the balance, after

deducting fees. The key benefits of e-invoicing based discounting are:- • Fully automated communication of e-invoices eligible for discounting to the

financial institution. Full authentication of the e-invoice source. • Increased security of transaction with the identity of the supplier and buyer being

authenticated within the e-invoicing network. • Improved reconciliation and payment visibility. • Historic transaction history for risk evaluation.

“The integration of B2B networks, corporate cash management and trade financing offers many exciting new innovations” Ifor Williams, Fundtech FSC



E-invoicing and Supplier Financing Supplier financing (also known as reverse factoring and occasionally as buyer driven receivables program – BDRP) is a more solid form of financing than standard factoring or invoice discounting. While those methods revolve around the supplier’s receivables of many -- perhaps unknown -- buyers, reverse factoring is based on the payables of one buyer that is well known to the bank, thus reducing risk. The specific steps are: 1. The buyer approves a purchase invoice for payment. 2. The buyer then allows a third party to offer to pay the supplier on its behalf. 3. The supplier receives a funding offer from a third party for its receivables in a process overseen by the buyer. 4. The supplier accepts the advance funding offer. 5. The financing institution advances a payment to the supplier. The amount is a substantial portion of the invoice value. 6. At some later date, the buyer pays the financing institution. The remainder of the invoice amount is paid to the supplier

minus fees. This process benefits both the buyer and supplier. The buyers are able to tap into third-party sources of liquidity to fund their payables in the short term, as well as gain flexibility in managing their working capital. The process also matches buyers’ payables with underlying cash flow, improves the stability of the supplier base while reducing supply chain risk, enhances the buyer-supplier relationship and improves the competitiveness of the buying organization. Since the buyer approves the invoice and initiates the financing opportunity, the cost of financing is based on the creditworthiness of the buyer, a significant benefit to smaller suppliers. Other benefits to suppliers include having ready access to funding on a day-to-day basis, reducing debt and days sales outstanding, and increasing the flexibility of managing working capital. The key benefits of e-invoicing based supplier finance are: • Immediate communication of invoice approval status between the buyer and the financing institution - initiating the

payment process. • Automated communication of payables details to the financial institution. • Support for the entire procure-to-pay process with electronic purchase orders and electronic goods documentation. • An existing critical mass of payables than can be selected for financing.

E-invoicing Allows Dynamic Payables Discounting An effective dynamic payables discounting solution can only be implemented using an e-invoicing service. In this scenario, a buyer receives a discount for paying an invoice early. The discounts can be calculated a number of ways. Suppliers may agree to accept early-payment discounts on all invoices, or only those that meet certain criteria. They may offer a discount on payments made by a single cut-off date, or impose a sliding scale based on when an invoice is paid. The main early-payment discount mechanisms are:

Simple discount: A single discount (e.g. 2%) if an invoice is paid within a specified number of days (e.g. 10 days). Otherwise the invoice is paid in full at the due date.

T iered discount: where multiple cut-off dates are defined. In addition to the simple scenario, additional intervals are defined (e.g. 1% discount if the invoice is paid within 20 days).

Scaled discount: The discounts are available on a continuous sliding scale, proportional to the number of days since the invoice was issued. within 20 days).



Buyers able to fund early-payment discounts from their own working capital can achieve excellent returns. A buyer regularly paying invoices after 10 days and earning 2% discounts is effectively receiving a 2% return on the amount over 20 days every payment cycle. Over the course of a year, the 2% return translates into an effective annual interest rate of 44%. Financial institutions may step in on behalf of buyers unable to fund early-payment discounts from their own working capital. The steps of this scenario are as follows: • A buyer agrees to pay an invoice, creating a payment obligation • This payment obligation is presented to a third party for funding • Invoice data is matched against the purchase order and against goods-received data. Besides earning a return on their capital, buyers benefit by proving liquidity at critical junctures to their suppliers, promoting their growth and stability. Suppliers meanwhile gain low-cost access to capital, as well as greater certainty around the timing and amount of payments. They also reduce their days sales outstanding and collection costs. Dynamic payables discounting is virtually impossible without an e-invoicing system to support the process. That is because in the paper world, invoices often do not even get to the accounts payable department until they are already past due, putting discounts out of reach. An effective e-invoicing system enables invoice data to be exchanged in real time. Queries can also be communicated in real time, smoothing and speeding the process.

Summary and Conclusions While the financial crisis has brought the end of cheap credit, it has also accelerated the trend toward supply chain finance. Such loans work well in a regulatory environment that emphasises capital and continues to put pressure on traditional credit. The loans also live up to heightened risk-management requirements. Because the loans are extended based on approved transactions, risk is contained. Banks can more fully take advantage of all the benefits of supply chain finance when they also deploy an e-invoicing service in support of it. E-invoicing permits supply chain finance to occur automatically, without the involvement of human staff. With a fully functional e-invoicing system working in support of supply chain finance, banks can achieve greater levels of revenue and growth, while keeping risk at bay. For further details please contact: Fundtech Fundtech FSC Ltd Llys Helyg, Ffordd y Llyn Parc Menai, Bangor Gwynedd LL57 4EZ Tel: +44 (0) 845 120 8050 Email: [email protected] E-invoicing Product Website: www.accountis.com

Fundtech white paper, e invoicing provides new avenues for credit

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