Invoice Factoring: How it Helps SME Exporters
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If there’s anything that unites small exporters, regardless of what they produce, it is the looming spectre of a cash crunch. No matter how well organized a company’s finances may be, there are always going to be some bills that are paid late despite invoices being sent on time. With lack of adequate trade finance, such delays can hit hard and exporters are caught between a rock and a hard place, often having to meet export orders on time without receiving payment for those goods.
Enter invoice factoring, a useful tool where an exporter can sell its invoices (or account receivables) to a third party, or factor, for cash up front.
Banks demand collateral from companies that seek loans to meet working capital needs. In some cases where banks do not seek collateral, the SME’s financial records do not meet the bank’s requirements. The problem with regulatory approvals is that it’s a double-edged sword: they are needed to ensure that financial institutions do not suffer in case of widespread default, but they hurt borrowers by being too rigid and way too time consuming.
The way out, as has been pointed out by numerous research agencies, is technology. Fintech companies use automated risk assessment models and tech-enabled systems that reduce, if not eliminate, paperwork. Fintech companies are uniquely positioned to help SME exporters because they can use technology to leapfrog the cumbersome paperwork and red-tape that bog down traditional lending institutions. For the SME, it means far less time and trouble spent in getting credit.
Invoice Factoring: One Stop Solution?
Private financing agencies along with several fintech start-ups are trying to ease access to credit by offering solutions such as invoice factoring and collateral-free loans. There is a severe trade finance gap. The gap is estimated at $1.5 trillion in emerging markets including India and China.
For SME exporters, invoice factoring is a solution for their trade finance-related woes. It works for them in two very clear ways. One, their working capital needs are met without looking for credit in multiple places. Two, the less evident advantage, is that it mitigates credit risk. The way invoice factoring works is that the factor buys the invoices by paying about 80 per cent of the value upfront. The remaining amount is transferred to the SME (minus processing and other fees) when the factor receives the payment. This means that for a small fee, the SME is rid of the trouble of following up on invoices and waiting for payment.
Of course, both SME and factor need to understand the business well, and also understand the need to maintain cordial relations with buyers. If the buyer is in a country with restrictive rules regarding forex payment and the like, it could end up being a long and expensive process to get the invoice paid. This is one reason why fintech companies that offer invoice factoring prefer to specialize in certain sectors as well as specific export destinations.
Invoice factoring, ultimately, is a convenient and fast way for an SME to get cash infusion without taking on debt. It allows an exporter to continue its business without being strapped for funds and without having to spend time and money in chasing payments.