The COVID-19 pandemic has increased borrowing from businesses across the UK, including those that may never have borrowed before. But as government support packages are eased in the wake of Britain’s reopening, many SMEs that depended on financial aid during the crisis face uncertainty.
Receivables finance offers a critical means to plug that potential funding gap, but specialist lenders must ensure their products are as efficient and customer-friendly as possible, particularly as fintechs disrupt the market and gain market share.
“Open Accounting” – a practice that enables the provision of better lending products for SMEs and an additional layer of risk and fraud controls for lenders through the transparent sharing of accounting information – offers a means for these specialist lenders to step up to meet this challenge.
Automating data extraction
Traditionally, invoice discounting processes have been largely manual and labour intensive not only leading to inefficiencies and risks for lenders but also friction for clients. This is largely owed to the fact that lenders rely on a bulk collateral position, with only the total balance of the sales ledger upon which to base funding. Tracking the client’s view of the sales ledger versus the cash collections received by the lender, with the inherent risk of dilutions and fraud, is critical to understanding the true value of the collateral. As a result, both the lender and the client must carry out non-value creating activity to ensure that the sales ledger position the lender is funding against is correct. This is coupled with the need for reserves and disapprovals, for example for age, contras or debtor-credit risk, to be calculated manually and then input into the lender’s systems, typically monthly.
This approach is cumbersome and arguably, the decisions taken are quickly out of date, impacting the risk mitigation decisions taken, which may be detrimental to both the lender and the client. That said, this intensive scrutiny of the sales ledger, even if only monthly, keeps the lender on top of the receivables and reduces the risk of issues going undetected. Laborious, but a necessary evil.
Lenders could approach this task more efficiently, in the wake of the pandemic and increased borrowing demand, by automating the creation of shadow ledgers - essentially a copy of information and detail within a client’s accounting system. Extracting this information has long posed a challenge for lenders and their clients, but Open Accounting has addressed this as a technology that can automatically collect this data. This level of transparency and insight enables far more informed and data-led decisions on invoice discounting facilities with more timely, efficient and accurate risk controls in place for the lender.
Enhanced lending opportunities
As a lender, leveraging Open Accounting can give a more accurate view of the risk. However, lenders should also consider how clients could also benefit from the opportunity to access increasingly tailored, additional products and services - including credit insurance, outsourced or guided credit control and payables management. This approach also offers a fantastic opportunity to extend invoice discounting facilities to businesses that would otherwise be destined for factoring solutions or forced to seek funding from more expensive sources.
Over the last decade, there has been a sizable shift in demand concerning accounting software. In 2008 a Software Satisfaction Survey claimed the use of online accounting software was almost 10%. A more recent survey reported that 58% of large companies are utilizing cloud accounting services, and by the end of 2020, 78% of small businesses would be relying solely on cloud technology.
Whether it be regulation or changes to customer expectations, a long tail of accounting packages has emerged with the cloud accounting software market value currently projected to reach over £3 billion by 2023.
The ability to seamlessly connect to a business’s accounting solution is becoming increasingly standardised through open-API gateways - although there is still a cohort of businesses (for reasons of scale or other rationales) who use traditional accounting software. Lenders need Open Accounting solutions that can deal with a wide variety of businesses and not be overly prescriptive on how a business should conduct its affairs. Nevertheless, the general adoption of cloud computing by businesses is a growing trend, accelerated by the pandemic and the need to rethink their business operating models.
Technology has advanced such that even larger businesses, with voluminous amounts of customer and invoice data, can be managed on a shadow ledger basis - from automated integration to more complex ERP systems, including multi-currency and when catering for a combination of domestic and export business needs.
Shadow ledgers are often a necessity in jurisdictions where invoices must be purchased on a non-recourse basis, and debtor credit risk is even more important from a lender’s perspective.
This is all good news for lenders and clients alike. With the rising cost of fraud - currently at $5 trillion a year - threatening to discourage banks from lending to businesses on a bulk invoice discounting basis, increased transparency and confidence is crucial. Lenders can gain additional reassurance from the outset that they are working with a legitimate business, while clients can access the optimised funding they critically need efficiently. Given the ability of lenders to offer increasingly tailored services, it also makes for longer, fruitful relationships and ultimately a stronger portfolio for lenders.
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First appeared on: TRF News