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Factoring as a fair substitution to a small business loan

20.01.2012

Maxim Solntsev, SDM-Bank CEO.

The issue of how difficult it is to obtain a SME loan is discussed all around, especially when it comes to a loan for a company with no decent collateral. But the fact is, bank loans are not the only way to arrange SME financing. Another way of funding is factoring, which is becoming more and more popular these days, and which uses accounts receivable from some large-scale enterprise or store chain as collateral.

The years of financial turmoil forced businessmen to be more attentive and careful, made them much more discerning in relation to credit risks. And factoring is now becoming more popular among SMEs, as the information on the sources of financing that are different from regular loans becomes widely available.

This option is particularly attractive to retailers and service companies, since many of them hold most of their facilities and equipment on lease. This means they have basically nothing to offer as collateral to a loan. But their customers are large-scale enterprises and store chains, and receivables from them may be used as collateral.

In practice, large-scale trade companies and store chains defer settling accounts with their suppliers. But suppliers can’t wait for a month or two (and sometimes larger-scale companies defer their payments for up to 90 days), and this is where factoring can help.

The supplier company can sell such accounts receivable to a bank or to some special factoring company. The bank then makes an advance transfer in amount of 75-90% of cost of goods sold under these receivables. When the real payment comes due, the debtor then pays the specified amount to the company’s factoring account in a bank. And then the proceeds net of earlier provided advance and interest are transferred to the supplier.

The deal is beneficial to everyone: suppliers can promptly raise working capital, store chains have an opportunity to substantially defer their payments for deliveries, and banks make their gains on commission and interest.

With that, store chains have an opportunity to increase procurement volumes, to expand their assortment, manage inventory and be certain that their suppliers will keep making deliveries in a timely manner with no concern over payment arrears. And this, in its turn, will as well enable store chains to be better-flexible in relation to their customers as well.

For SMEs factoring is the mean of minimizing risks in dealing with their debtors. It enables suppliers working with deferred payments to cope with working capital financing issues, raising capital for business development, and new customer acquisition. And therefore it becomes one of the principal tools in SMEs financing policies.

It is essential to SMEs that the bank initiates transfer as soon as delivery documents are submitted. If a company supplies goods or services with an option of payment deferral, but still does not want to leave the hole in its balance for that long, then factoring would be the best financing mean for this company. With this option now available to SMEs, they don’t need to turn down orders on the ground of payment deferral problems. More to that, a company may improve its competitive advantage by giving more time to its customers for settlement of accounts. And sure factoring is the best deal for those companies which have nothing but accounts receivable to use as collateral.

There are two types of factoring – the recourse factoring and non-recourse factoring. The non-recourse factoring supposes that a bank or a factoring company runs all the risks related to possible refusal of a debtor to pay its debt. The recourse factoring in its turn means that if a debtor refuses to pay its bills, then the bank has a right to demand from both the debtor and the supplier to reimburse the amount provided, including factoring commission.

The non-recourse factoring allows suppliers to avoid the necessity of constant tracking of the financial solvency of its debtors, while the recourse factoring is convenient for those who have loyal and standing customers. Although, the non-recourse factoring interest rate is materially higher than the one of recourse factoring. And at this time the non-recourse factoring is barely used on the Russian market.

It is much easier to obtain factoring financing than a loan, and this is true from the perspective of procedure as well: there is no need to asses collateral, and it involves much less bureaucracy. A bank, in its turn, has an advantage of much smaller default risk, compared to a classic loan: in this case collateral is receivables from a large-scale business.

The numbers also tell in favor of factoring being popular among Russian businessmen: according to survey conducted by Association of Factoring Companies among banks and companies that hold up to 99% of factoring market, the volumes of this business for the 9 months of 2011 reached RUB 575 bln. The growth rate from the same period a year earlier is as high as 90%.

This numbers show an explicit interest of customers toward factoring services. The growing number of companies that work with deferred payments see factoring as a fast and effective way of working capital replenishment. These trends show that Russian factoring market development prospects look quite positive, and, according to experts, this dynamics will remain unchanged in a long term period.

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