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Receivable Purchase Agreement and increased shareholder value

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A Receivable Purchase Agreement ("RPA") is a financial arrangement between a bank or financial institution and a company, where the bank provides liquidity to the company by purchasing its undue account receivables. The agreement regulates the purchasing process, terms and conditions and how the cash flow will work. The bank is buying the creditors rights in the Account Receivables (“AR”) from the company (seller), against the buyer (debtor), under the current applicable commercial conditions.

Figure 1 below illustrates how the agreement works in practice. In step 1 the seller issues invoices assigned to the bank. When the bank has received the AR report containing the receivables, it will pay the seller the face value of the receivables minus the discount fee, and sends a purchase report back to the seller (step 2-3).
In many cases the bank will also demand that the receivables are insured by a credit insurance company. The buyer (debtors) will thereafter on due date pay face value to the new collection account, set up by the bank (step 4). For accounting and collection purposes, the seller will get reading access to the new collection account.  Ilustration RPA_DNB.PNGFigure 1 -RPA work flow

 

 

Effects and benefits
There are many incentives for setting up an RPA. Bellow are the most important to bear in mind when managing working capital.

 

  • Risk management
    By setting up a RPA the seller will reduce the credit risk on the buyer and possible currency risk, through receiving settlement much earlier. The bank will also take over the late payment risk on the buyer. 

  • Improvement of Cash Conversion Cycle, key figures and shareholder value. 
    Most companies have a substantial proportion of its assets tied up in its working capital. A common way to illustrate the working capital is with Cash Conversion Cycle ("CCC"). The formula express how many days it will take to convert the resources tied up in assets in to cash flow. By selling its inventory, collect receivables and the length of time it has to pay its bill and obligations, before it will result in penalties. It is calculated by adding Days Inventory Outstanding ("DIO") and Days Sales Outstanding ("DSO") subtracted with Days Payable Outstanding ("DPO").
    Depending on the sellers current average DSO, a RPA can have a significant effect on the Cash Conversion Cycle.
    The example below is a 2 billion company with an EBITDA MNOK 0,11 EBIT of MNOK 0,95 who is  estimating to reduce its DSO with thirty days. 

Eksempel nøkkeltal.png    Eksempel balanse.png

Example - Simulated effects in the balance sheet.
 

The free cash flow can for example be reinvested into new productive projects, that can enhance revenue. It can also be used to paying down short term debt and improve key figures such as NIBD/EBITDA or ROCE.

 

Free cash flow has also a positive effect on shareholders wealth. In the study Working Capital Management and shareholder Wealth by Robert Kieschnick, Mark laPlate and Rabin Moussawi (2012), the author finds clear evidence that a dollar in cash is valued almost twice than a dollar invested in net working capital. This conclusion is also supported by the results in the French study Working capital and Firm Value by Autukaite and E.Molay.


The study of Kieschnick et al can be read at the Social Science Research Network ("SSRN") at the following link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1431165 - enjoy Smiley Happy