Receivables, payables, and inventory - Factoring, invoice di...

Learning Outcomes

After reading this article, you will be able to explain the purpose and mechanism of factoring, invoice discounting, and supply chain finance. You will identify their impact on receivables, payables, and inventory management, assess the benefits and risks of each approach, and evaluate how these methods influence liquidity, working capital cycles, and credit risk in both domestic and multinational contexts.

ACCA Advanced Financial Management (AFM) Syllabus

For ACCA Advanced Financial Management (AFM), you are required to understand how advanced working capital solutions improve financial management. In particular, focus your revision on:

• The management of receivables, payables, and inventory to optimise working capital
• The principles, process, and implications of factoring, invoice discounting, and supply chain finance
• Evaluation of the financial, commercial, and risk-related impacts of these techniques for multinationals
• The role of these strategies in funding, liquidity, and risk transfer
• The assessment of costs, benefits, and practical considerations for implementing these solutions

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which technique typically involves the outright sale of accounts receivable to a third party?
   1. Invoice discounting
   2. Factoring
   3. Supply chain finance
   4. Inventory finance

2. What main risk is transferred away from a company when it uses non-recourse factoring?

3. Briefly describe how supply chain finance can support a supplier's cash flow without shortening the buyer’s payment terms.

4. List two key differences between factoring and invoice discounting in terms of control and disclosure.

Introduction

Modern firms must manage cash conversion cycles carefully to remain solvent and competitive. Efficient control of receivables, payables, and inventory is essential for releasing cash, minimising risk, and supporting growth—especially in multinational contexts. Factoring, invoice discounting, and supply chain finance are specialised working capital solutions used to improve liquidity, reduce risk, and optimise the balance sheet. Understanding how these methods work and their implications for financial management is critical for the ACCA AFM exam.

RECEIVABLES MANAGEMENT: FACTORING AND INVOICE DISCOUNTING

Many businesses face delays from customers settling invoices. These delays can cause cash flow constraints and increased credit risk. Factoring and invoice discounting are two prominent solutions for releasing cash tied up in receivables.

Factoring: Structure and Mechanisms

Factoring involves selling trade receivables to a third-party finance company, known as a factor, at a discount. The factor provides immediate funds to the business, typically advancing a large proportion of the invoice value (often 70–90%), and then collects payment from debtors. The factor charges a fee for the service.

Key Term: factoring
An arrangement where a business sells its trade receivables to a specialist finance provider (the factor), who typically advances cash and assumes responsibility for collections and, in some cases, the credit risk.

Factoring may be with or without recourse:

• With recourse: The business must compensate the factor if the debtor defaults.
• Without recourse: The factor accepts full credit risk for non-payment.

Advantages and Disadvantages of Factoring

• Benefits include improved liquidity, reduced administration, and possible credit risk transfer (non-recourse).
• Costs include service charges and interest on advances, possibly making this solution expensive.
• Customer relationships may be affected, as customers interact with the factor directly.

Invoice Discounting: Principles and Application

Invoice discounting is similar in that it frees cash from receivables, but differs significantly in execution: the business borrows against unpaid invoices, which are pledged as security, but retains responsibility for collections and debtor relationships. Customers are not informed of the arrangement.

Key Term: invoice discounting
A finance facility where a business retains control of its debtor ledger, using its receivables as security for short-term borrowing, without notifying customers.

Factoring vs. Invoice Discounting

• Disclosure: Factoring is disclosed to customers; invoice discounting is confidential.
• Control: Factoring transfers collections to the finance provider; invoice discounting leaves collections with the business.
• Risk Transfer: Non-recourse factoring can transfer credit risk; invoice discounting typically does not.

Worked Example 1.1

A manufacturing company has $500,000 in trade receivables with average collection terms of 60 days. Management is considering factoring (with recourse), at a 2% annual service charge and borrowing rate of 8% per annum. Alternatively, invoice discounting is offered at 6% annual interest, with no service fee.

Determine which facility provides lower total costs over a year, ignoring VAT and tax.

Answer:
Factoring: Service charge = $500,000 × 2% = $10,000.
Interest (average period: 60/365 × 8% × $500,000) = $6,575 approx.
Total cost = $16,575.
Invoice discounting: Interest = 6% × $500,000 × (60/365) = $4,110 approx.
Total cost = $4,110.
Invoice discounting is less costly in this example. However, risk transfer and other qualitative factors should be considered before making a decision.

PAYABLES MANAGEMENT AND SUPPLY CHAIN FINANCE

Efficient payables management supports both buyer liquidity and supplier financial health. Supply chain finance (SCF) solutions can deliver benefits to both parties—especially in large, international supply chains.

Supply Chain Finance: Definition and Operation

Key Term: supply chain finance
A set of structured solutions enabling suppliers to access early payment on invoices, typically at a lower finance cost, based on the buyer’s creditworthiness and using a financial intermediary.

With supply chain finance, the buyer (usually with a higher credit rating) agrees to approve supplier invoices early, allowing the supplier to receive immediate payment from a financier, while the buyer settles the invoice later on standard or even extended terms.

Advantages:

• Suppliers access working capital at cost-effective rates.
• Buyers can negotiate longer payment periods without harming supplier liquidity.
• Strengthens supplier relationships and the stability of the supply chain.

Risks and practicalities:

• Requires robust technology and trust.
• Dependent on the buyer’s credit profile; changes may affect facility terms.
• Can complicate supplier relationships if not communicated clearly.

Worked Example 1.2

An electronics retailer has a supply chain finance programme with its key supplier. Once the buyer approves an invoice for $200,000, the supplier can opt for early payment from the buyer’s bank (less a finance fee of 1% for 30 days) instead of waiting for the buyer’s standard 60-day payment term.

If the supplier chooses early payment, how much cash will it receive, and what impact does this have on both supplier and buyer?

Answer:
Early payment: $200,000 – (1% × $200,000) = $198,000 received immediately.
Supplier: Receives earlier cash, improves liquidity.
Buyer: Pays full $200,000 after 60 days (per agreed terms), preserving its own cash flow.

INVENTORY FINANCE AND WORKING CAPITAL STRUCTURING

Beyond receivables and payables, businesses may seek to release cash from inventory holdings.

Key Term: inventory finance
A specialised loan or facility secured against the value of inventory, allowing a business to release working capital while holding stock.

Key Term: working capital cycle
The sequence and duration of converting cash into inventory, to receivables, and back into cash, highlighting the efficiency and funding needs of operational processes.

Worked Example 1.3

A food importer uses inventory finance to secure a loan against $1,000,000 of perishable stock at a 70% advance rate. The facility incurs a 7% annual interest rate. Calculate the monthly interest cost and explain any key operational risks.

Answer:
Available finance: $1,000,000 × 70% = $700,000.
Monthly interest: $700,000 × (7% ÷ 12) = $4,083.
Main risks: Stock becoming unsellable before sale, correct valuation, and lender's security if inventory loses value quickly.

RISK, COST, AND STRATEGIC CONSIDERATIONS

Each financing solution for receivables, payables, or inventory has implications for risk, cost, and control. Businesses must weigh factors such as:

• The trade-off between finance cost and flexibility.
• The impact of risk transfer—some methods shield the company from bad debts, while others do not.
• Disclosure to counterparties—factoring is typically visible to customers; invoice discounting is not.
• Administration and relationship management: factoring outsources credit control, which may or may not suit the business’s culture or customer base.
• The effect on reported balance sheets and key ratios.

Exam Warning

Examiners frequently test your ability to distinguish between disclosed and confidential arrangements. Always specify who controls collections and whether customers are informed.

Revision Tip

Practise constructing short pro/con tables for each facility; clear comparisons often earn easy marks in longer questions.

Summary

Factoring, invoice discounting, and supply chain finance provide strategic ways to optimise working capital and liquidity. Businesses can accelerate cash inflows, lengthen payables, and use inventory as security. Each method varies in risk, cost, disclosure, and operational effect. The careful selection and management of these solutions can significantly strengthen a company's financial strategy and stability.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain the mechanics and purpose of factoring, invoice discounting, and supply chain finance
• Differentiate between recourse and non-recourse factoring
• Identify key differences between factoring and invoice discounting (control, disclosure, risk transfer)
• Describe the process and advantages of supply chain finance for buyers and suppliers
• Discuss inventory finance as a tool for releasing working capital
• Evaluate the risk, cost, and operational trade-offs of each working capital solution

Key Terms and Concepts

• factoring
• invoice discounting
• supply chain finance
• inventory finance
• working capital cycle