Non-Recourse Factoring: A Solution for the Economic Crisis for SMEs
We had the pleasure of speaking to Mr R. Yüce Uyanik, a member of the FCI Legal Committee, on international factoring as a solution for the economic crisis on SMEs.
Yüce Uyanik is a former factoring executive. Now, part time instructor at two universities in Istanbul on Foreign Trade, Finance, Accounting, Logistics and Sales Management subjects. An owner of a training consultancy company on Selling, Management and soft skills, Uyanik is also author of two books on Foreign Trade Transactions (2005) and Financing, International Factoring Rules (2002) and several scientific articles on private Law. Uyanik has been a member of the Legal committee of FCI since 2003.
Anytime there is an economic crisis in countries due to a recession or stagflation, small and medium-sized enterprises (SMEs) are highly affected due to a decrease in domestic demand. A decrease in domestic sales obliges SMEs to find new foreign markets and customers.
On the other hand, exporting offers firms numerous advantages, but many firms have not seized the incredible opportunities that exist in the worldwide marketplace. There is a global economy, influenced by worldwide access to manufacturing technology, which has created competitive manufacturers with cheaper, faster, and better production. Many developing countries have become serious rivals to established economies due to their links with global communication systems, the development of communication, print, and electronic access to information. There has never been a more opportune time for companies to capitalise on these market shifts and to export.
Why firms export
|Increase sales and profits||If a firm is performing well domestically, expansion into foreign markets is likely to improve its profitability.|
|Gain global market share||By exporting, a firm will learn from its competitors – their strategies and what they have done to gain a share in foreign markets.|
|Reduce dependence on existing domestic markets||By expanding into foreign markets, a firm will increase its marketing base, and reduce its dependence on local customers.|
|Offset market fluctuations||By tapping global markets, firms are no longer held captive to economic changes, varying consumer demand, and seasonal fluctuations within the domestic economy.|
|Make use of excess production capacity||Exporting can increase the utilisation of production capacity and length of production runs, thereby reducing average unit costs, and achieving economies of scale.|
|Enhance competitiveness||Exporting enhances a firm’s and a country’s competitive advantage. While the firm will benefit from exposure to new technologies, methods and processes; the country will benefit from an improved balance of trade.|
Exporting of individual companies has also some macroeconomic advantages for the country that are;
Creating domestic jobs. Exports of goods and services support new employment opportunities and decrease the rate of unemployment.
Helping to reduce the trade deficit. Increasing exports will reduce the difference between imports and exports.
However, due to the increase in global competition, penetration to a new market is not easy and is going to get more difficult in time as the competition is getting more and more intense. It is almost impossible to convince a new customer without accepting their buying conditions.
Normal request of a selling company is having profitable and securitised sales. Under normal conditions, this is very difficult unless the seller is a monopoly. Then, the normal requirements of buyers will be applicable: open account transactions without any bank guarantee (No cash, letter of credit, guaranteed draft or letter of guarantee etc.)
Even though an SME is ready to sell with smaller profit margins in a foreign new market, the risk of non-payment may prevent them from agreeing in such selling conditions. SMEs will choose either to take this high risk of losing money for tiny profits or to refuse such orders albeit their need to sell, a difficult decision to make.
There is only one financial instrument to solve this problem, which offers the sellers to sell in cash and 100% guaranteed and gives the buyers the opportunity to buy open account, without giving any bank guarantee, therefore creating an environment for both parties to agree. This instrument is NON RECOURSE FACTORING.
Non-Recourse Factoring – Explained
Non-recourse factoring essentially is the sale of the receivables and transfers the ownership of the receivables to the factor, who obtains all rights and risks associated with the receivables. The factor collects the payments from the debtor directly and carries the risk of bad debts if any[ii].
The following is an example of how non-recourse international factoring operates.
Assume that a Turkish company tries to export to a firm in Germany. The German buyer places the order for €3 million for goods to be shipped within a year. The transaction will be open account with 60 days term. As the Turkish company doesn’t know and comfortable about the new German buyer will probably reject to sell against such a life-saving order in an economic crisis, if they are not aware of factoring.
Indeed, if the Turkish exporter applies to a factoring company in Turkey who has correspondents operating in Germany and the buyer is approved by the German import factor, the problem will be solved. The seller will assign their receivable that arises from the shipment of the goods to the export factor in Turkey. The Turkish export factor will assign the receivable to the German debtor who will be the owner of the receivable and to provide collection, bookkeeping and protection against bad debt functions under their approval.
By approving the receivable factors undertake the credit risk beside their collection function. Credit risk here means the risk of non-payment of the debtor of the approved receivable within 90 days after its due date for any reason other than a dispute.
Therefore the seller knows that they will be able to get the amount of the receivable at most within 90 days after its due date if they have fulfilled all his obligations in terms of the sales contract even if the debtor fails. Any action related to the collection of the receivable will be done by the new owners of the receivable, factors.
Further to this, the export factor may propose the seller to prepay a major part of their debt to the seller, generally 80%, after the assignment, whenever required. The retained part, 20% is paid after the collection or 90th day after the due date of the receivable under approval after deduction of related charges. This is not different than selling in cash for 80%.
Thanks to factoring, the seller is able to sell in cash (80%) and with 100% factoring guarantee; and the buyer is able to buy open account with term payment. Both parties are satisfied and the trade occurs. Cash received from the factor will enable the seller to produce more goods to sell, thus decreases the receivable turnover period and will increase the sales volume and profits, not only by finding new customers also by increasing productivity and growth with a better balance sheet.
Due to the import factor’s continuous monitoring and supervision on the debtors, collection function and 100% protection, factoring has a relative advantage over the credit insurance.
Non-recourse international factoring has similarities with credit card transactions of banks. Credit cards transactions are between individuals and sellers, factoring is for B2B sales.
Factoring, therefore, gives the opportunity to exporters to enter foreign new markets easily even under economic crisis where the domestic market suffers from the recession. Using the advantages provided by factoring, individual sellers in a country will be able to increase their export volume which will have a positive effect on the country’s exports and balance of payments. This will also be beneficial for the country to overcome the problem of recession.
One may ask why factoring is not known and used by companies, especially the SMEs if it is so beneficial. It is a very good question. The answer lies within the question. It is not known well. Although roots of factoring go to thousands year ago, modern factoring is relatively new. It is generally considered as a financing product (money lending) only and thought that is an alternative of bank loans, which is not totally correct. Financing is a secondary, optional function of factoring.
Whatever the reason for not knowing is, especially non-recourse international factoring is one of the best remedies to avoid fluctuations in the economy and crisis. Tradesmen and industrialists should try to understand what factoring is and see the advantages that factoring provides to them and take the necessary steps to benefit from factoring.
Factoring creates a multiplier effect for companies, especially SMEs and their countries in the exports volume and profitability, not only in crisis but also in all times whenever easy, comfortable and healthy growth is required.
This article was brought to you by FCI, Trade Finance Global’s Factoring and Receivables partners.
[i] Trade Secrets, World Trade Organization, 2000
[ii] Ciby Joseph, Advanced Credit Risk Analysis and Management, John Wiley & Sons, Ltd. 2013, p.322