NEW DELHI: New-age financing mechanisms are often considered as the need of the hour for the credit-starved small and medium enterprises (SMEs) in India. And a trend, which is slowly gaining ground, where the financial service providers are finding it as a lucrative option is factoring services. As the market of SME financing enjoys considerable business opportunity, the new entrants are eyeing to capture the thriving segment.
Market players often say that access to capital is one of the major bottlenecks that impacts the growth of SMEs in India.
Various SME promoters have invested their own funds in fixed assets with the aim to run business effectively. Although, India has witnessed considerable progress in the area of channelising finance to SMEs, but with the ongoing economic slowdown, it assumes significance. Easy access to finance is a prime factor in deciding the competitiveness of the the small businesses in India and this is where the globally practiced tool known as 'Factoring' gains prominence.
Meaning of factoring
Factoring is considered as a type of receivables finance where a company either sells or assigns its accounts (known as invoices) to a finance player (Factor) to bag funding on an urgent basis so that business operations can be continued. It usually comprises of financing short-term receivables, offering credit protection against bad debts, collection of payment proceeds and also management of sales ledgers.
Moreover, it can be differentiated from a bank loan in three ways. Firstly, a bank loan comprises of two parties while factoring consists of three parties such as borrower, buyer and factor. Secondly, the stress is given on the quality of the receivables and not just on company’s credit worthiness. Thirdly, it is considered as an advance on any outstanding invoices.
Can SMEs afford factoring facilities?
Many SMEs ask if factoring is affordable and then the question arises - can a small business survive without using factoring as it is one of the survival tools in the present economic slowdown? All across the globe, factoring is one of the most sought after routes of accessing working capital for SMEs and also for larger organisations.
According to Factors Chain International (FCI), the global factoring turnover for 2010 was at Euro 1648 billion. The overall factoring turnover in India during last financial year 2011-12 touched Rs 19,000 crore, amounting to assets of about Rs 6,000 crore. These figures show that the factoring industry is still is at a nascent stage as it accounts for 0.24% of the banking assets which is lower as compared to the developed countries where it around 3.7%.
Meanwhile, a study by Credit Rating Information Service of India (CRISIL) states that SMEs can strengthen profits by at least 15% if they get payments on time from their big corporate customers. The timely payments from large customers have potential to help SMEs cut interest costs, bring improvement in profitability.
Presence of factoring facilities in India
In 1991, when economic liberalisation programme started in India, Reserve Bank of India (RBI) gave green signal to this facility for SMEs. But, small enterprises suffered due to the absence of adequate knowledge in this regard. But, with changing time, this trend is fading away as two third of the clientele of factoring service providers is now the SME segment and the count is likely to go up further in the coming years.
Factoring has potential to complement the financial supply chain of the clients as it brings improvement in the seller’s cash flow and and cover risks.
Companies offering factoring services in India
Many financial institutions such as banks, mainly foreign players have expressed keenness to foray into the factoring services business.
a) Banks - Foreign banking players like HSBC, Standard Chartered bank, Citibank enjoy some exposure in the business. The banks are foraying into factoring sector as the scope for financing large corporates is reaching to a saturation point. It is better to capture the SME segment as they would pay higher interest rates as compared to the large corporates.
In regard to domestic factoring business, SBI factors, Canbank factor and GTF contribute 90% of the market share, and rest of the share is contributed by the new players.
b) India Factoring & Finance Solutions Pvt Ltd - A joint venture of the state-run Punjab National Bank (PNB), Malta-based FIM BankGroup, Italy- based Banca IFIS, and Blend Financial Services, Mumbai, is slated to start services in cities Pune, Nashik, Nagpur, Aurangabad soon. It is also strengthening its factoring services in Maharashtra for entrepreneurs, small and medium enterprises (SMEs) and small-scale industries.
Presently, India Factoring offers financial solutions to more than 200 SMEs and SSIs in Delhi, Mumbai, Chennai, Bangalore, Kolkata, Ahmedabad and Hyderabad.
While speaking to SME News about factoring services, Sudeb Sarbadhikary, CEO and MD of India Factoring, said, “Factoring services help SME’s in unlocking liquidity from their established trade receivables while enabling them to focus on their core business. The industry has been provided with further impetus after the passing of the Factoring Regulation Act of 2011 wherein the process of assignment, rights and obligations of parties involves and terms of stamp duty exemption have been clearly defined for the first time. This is expected to provide factoring companies further teeth in enabling them to resolve disputes pertaining to collection of debt on factored invoices and is expected to provide a boost to the industry as a whole thus enabling SME’s to further gain under this.”
c) Small Industries Development Bank of India (SIDBI) – This financial institution is focusing on the micro, small and medium enterprises (MSMEs) to create awareness about factoring services among the SMEs.
Understanding the functionality of factoring facilities
A factoring pact for an agreed funding limit is signed, then the funding limit is broken down further for the customers. Thereby approved customers are informed about the assigning of receivables due from them to the factoring company and also they are needed to make direct payment to the factor. The goods/services and invoice to debtor are delivered. Accordingly, invoices are sent to factoring company, which advances up to 85% of invoice as a pre-payment.
After receiving funds, the factoring company waits to get paid by the debtor on the scheduled dates. When the factoring company gets paid, it refunds the remaining amount as the balance payment
Why factoring is better than traditional lending
- Bank finance needs collateral in the form of mortgage, whereas factoring is decided on the basis of quality of receivables and the buyer profile.
- Factoring is an open account facility and in other words it means that the credit limit rises as sales goes up. The fast growing SMEs who need more and more funding every year, factoring is the best option.
- As factoring is not exactly a loan, this facility offers liquidity and it does not add to the debt of the company.
- Factoring also offers collection services.
How to use factoring services
As factoring is focused on receivables, it is must for SMEs to discuss factoring with their buyers. If the buyer is convinced to pay directly to the factor, then the SME has attained its goal. Proper transaction documents like purchase orders/invoices/ lorry receipt helps in bagging sanction quickly.
If used smartly, factoring provides various benefits for growing SMEs that have rising funding needs. Although, it could be little costlier compared to bank finance, but the benefits have potential to outweigh the cost. It is believed that factoring is best suited for the fast growing SMEs.