Modern supply chains have grown longer and more complicated as trade becomes increasingly global in nature.

To cope with this expansion in trade, manufacturing and distribution companies have begun engaging in working relationships with several companies worldwide to procure raw materials/semi-finished goods or the final product.

Popular financing solutions like bank loans or working capital loans are expensive for suppliers in developing countries where credit is costly.

This has given rise to payables finance or accounts payable financing as a financial product.

In this article, we'll cover everything you need to know about payables finance, including what it is, how it works, and the benefits it offers.

What is Payables Finance?

Payables finance or accounts payable financing is a method of international trade finance that allows businesses to access the funds they need to pay their bills.

With payables finance, a lender provides short-term financing to a business based on the value of its outstanding invoices.

The lender pays the supplier on behalf of the business, and the business repays the lender at a later date.

Also known as reverse factoring, these solutions are generally far more cost-effective as they are initiated by medium-large-sized manufacturing or distribution firms having a healthy credit profile for the supplier’s benefit.

Parties Involved in Accounts Payable Financing

The parties involved in accounts payable financing are the borrower (the business who wants the funds), and a lending company like Drip Capital who offers trade finance solutions.

Payables financing takes two forms:-

1) Dynamic Discounting:-

Although relatively unknown, dynamic discounting is also a payable finance solution where a buyer gives the supplier the option of earlier payment terms in return for a discounted price on the goods/services purchased.

It is known as 'dynamic' as discounts vary depending on the payment dates chosen by the supplier. So, the earlier a payment is made, the greater the discount.

Also, the seller has the flexibility to either hold the invoice or demand payment depending on prevailing business conditions. Infographic on Dynamic Discounting

2) Buyer-Led Payables Finance:-

Unlike dynamic discounting, which is solely between buyers and suppliers, buyer’s finance is a supply chain finance (SCF) technique with a financial institution as an intermediary.

The buyer contracts with the financial institution to allow its suppliers to discount their invoices with the financial institution in return for early payment.

The buyer, in turn, agrees to pay the financial institution the total invoice value on the agreed due date.

This engagement is done under an Open Account (OA) basis, meaning the supplier and buyer need not enter into separate contracts for each shipment.

A typical SCF model

Infographic on Buyer led Payables Finance

Note: This article will be referring to ‘Payables Finance’ as the ‘Buyer-led Payables Finance’ product, as ‘Dynamic Discounting’ is often used in an independent context solely as an agreement between buyer and seller.

How Does Payables Finance Work?

Payables finance works by leveraging the creditworthiness of the business's suppliers.

  • The lender provides short-term financing to the business based on the value of its outstanding invoices.

  • The lender pays the supplier on behalf of the business, and the business repays the lender at a later date.

  • The terms of payables finance vary depending on the lender and the business's creditworthiness.

  • In most cases, the business will need to have a good credit score and a track record of paying its bills on time to be eligible for payables finance.

Example of Payable Finance

Consider a small business has an invoice for $10,000 which is due in 30 days. Instead of waiting for the payment to come in, the business can use payable finance to obtain funding for a percentage of the invoice amount upfront, from a trade finance company. The company will charge a fee or interest rate for the loan, and the business will pay back the loan amount plus interest when the invoice is paid.

Payment Terms under Payable Finance

Payables finance under SCF agreements typically begins with the financial institution's creditworthiness study of the buyer.

Once done, a solution is agreed upon, with the buyer specifying a set of suppliers it does business with and the financial institution providing a mutually agreed upon discounting schedule.

The financial institution then onboards these suppliers with the provision of their Know Your Client (KYC) documents.

Every transaction is triggered by the buyer unconditionally approving an invoice or account payable.

This is usually done electronically, making the approval process instantaneous and constitutes an obligation by the buyer to pay the invoice amount on the due date.

The seller now has the option to hold on to the invoice for full payment at maturity or discount it with the financial institution at the agreed-upon rate.

Although the buyer initiates the financing request, the payments are made directly to the supplier’s account.

How to Apply for Payables Financing

1. Evaluate your business needs:

Before you apply for payable financing, determine how much funding your business needs. Consider your amount of outstanding accounts payable and how quickly you need the funding.

2. Find a lender:

There are several lenders that offer payable financing, including banks, alternative lenders, and online lenders. Do your research on your options while comparing rates, terms, and fees to find the right one for you.

3. Gather necessary documentation:

To apply for payable financing, you will need to provide documentation that shows your accounts payable, including invoices and purchase orders.

4. Submit your application:

Once you have found a lending company and gathered the necessary documentation, you submit your application for payable financing.

The lender reviews your application and assesses your creditworthiness before approving or denying your request.

5. Receive funding:

If your application is approved, the lender will provide you with funding based on a percentage of your outstanding accounts payable.

You will then repay the loan plus interest or fees when the invoice is paid.

Benefits of Payables Financing

Regardless of which payables financing option a company chooses, both parties can mutually benefit.

Benefits for Buyers:-

  • Stability in supply chains, ensuring operational continuity for buyers.
  • Working capital concerns being addressed ensure better relations with suppliers.
  • Shorter CCC with improved payment terms and thus better liquidity position.
  • The automated payment process leads to streamlined operations.

Benefits for Sellers:-

  • Securing funding at lower costs compared to traditional banking sources by leveraging the buyer's credit rating.
  • Greater visibility of working capital and cash flows leads to better forecasting and flexibility to finance or hold the invoice till maturity.
  • Reducing the impact of longer payment terms demanded by financially-powerful buyers.

How is Payables Financing Different from other Forms of Funding?

Payables financing is different from other financing solutions such as receivables financing, invoice financing, and forfaiting in the following ways:

1. Collateral:

The borrower uses its accounts payable as collateral to obtain funding which is different from collateral-free lending methods.

2. Risk:

Payables financing is generally considered less risky for lenders owing to the presence of collateral. This can lead to lower interest rates or fees for the borrower as compared to other forms financing solutions.

3. Credit History:

Unlike other funding solutions, payable financing does not require any personal guarantee or extensive credit history. This makes the process of borrowing seamless and easy.

Is Payables Financing the Right Option?

Payables finance is a tremendous competitive advantage for businesses and their suppliers.

This is especially so for companies with extensive supply chains spanning various geographies.

Manufacturing companies are an obvious beneficiary as they typically carry a lot of inventory and deal with many suppliers.

Also, distribution companies that typically hold a lot of inventory can benefit from a payables finance solution.

Overall, this financing solution is ideal if the company:-

  • Has a high transaction turnover
  • Has a large proportion of working capital to revenues
  • Has a relatively large cash conversion cycle
  • Operates on medium-thin margins
  • Works with a variety of suppliers with different financial requirements
  • Regularly faces fluctuating demand and supply curves
  • Has a moderate to healthy credit rating

FAQs on Payables Finance

Q: Is payables finance the same as factoring?

A: No, payables finance and factoring are two different financing solutions. Factoring involves the sale of a business's accounts receivable to a third party, while payables finance involves the borrowing of funds against a business's accounts payable.

Q: Who is eligible for payables finance?

A: Eligibility for payables finance depends on the lender and the business's creditworthiness. In most cases, businesses need to have a good credit score and a track record of paying their bills on time

Q: Is accounts payable a financing cash flow?

Accounts payable is a financing cash flow as it refers to the cash inflow a company receives funding by using its accounts payable as collateral.

Why Choose Drip Capital?

As a technology-enabled trade finance company that provides effective working capital solutions for importers/buyers in the US, Drip Capital offers payables finance solutions for importers looking to secure strong working relationships with suppliers worldwide while leveraging its own creditworthiness.

To date, Drip Capital has facilitated 50,000 cross-border trade transactions across 100+ countries and assisted SMBs in growing their business by ensuring liquidity constraints are addressed for all the parties in a given trade transaction.

The Drip Capital Advantage

  • Collateral-free financing

Fund sales growth with outstanding trade receivables without the need for any collateral.

  • Completely digitized onboarding and disbursing process

An automated process ensures minimal manual intervention and quick disbursements to address business exigencies.

  • A personalized service

A dedicated account manager to handle all interactions and promptly resolve any issues.