Your Largest Unprotected Asset – Accounts Receivable

Accounts receivable can dominate a company’s balance sheet.  In Canada, they comprise up to 40% of a Canadian company’s total assets.  But what makes them challenging to finance are invoices that are neither date certain nor amount certain for payment.  This creates a significant valuation discount (15% to 50%) in traditional financing methods.   Let’s face it, receivables are OPAQUE.  Anyone can issue an Invoice and claim it’s a receivable.

However, receivables have very attractive risk characteristics that make them attractive for finance:

  • Short duration (typically less than 180 days),
  • Favorable structural issues - receivables normally occur at the company operating level, making them senior debt compared to obligations at the holding company level.
  • Favorable treatment in bankruptcy - In trying to keep the company or its operating subsidiary as a going concern, an administrator may be forced to exclude some trade creditors from restructuring negotiations in order to maximize future enterprise value.

Like mortgage insurance, receivables insurance policy coverage can trigger more favorable finance rates and/or increase the percentage of financing on a receivables loan – allowing businesses to grow sales faster.   In my experience, there are four primary reasons insurance can be purchased

  1. incremental sales
  2. default risk protection
  3. as a financing tool and
  4. cost reduction

By far, risk mitigation is the primary reason and cost reduction (through lowering bad debt reserve) is the secondary reason mentioned by my corporate contacts.

However, Insurance cover to facilitate financing and lending on domestic and foreign receivables lending appears to be an area of great opportunity. What we have seen with companies that have gone this route is a substantial increase in their eligible assets for the lending pool . For example, if a bank client is borrowing at 6% over Libor, and has 70% of his receivables eligible, through insurance, they are able to get 85% of the pool at the same or better rate.

We will be looking at this market in more detail in our PRO section.

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