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Cash flow is King Factoring for SMEs in Singapore

SMEs have a range of options for raising money beyond traditional financing. One such option is factoring, under which a business sells its invoices to financial institutions (the factor) at a discount for immediate cash.

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Published by InCorp Global Pte Ltd
on 03 Apr 2017

Cash flow is King Factoring for SMEs in Singapore

It can be very difficult for Small and Medium Businesses (SMEs) to get traditional bank loans from risk- averse financial institutions. However, SMEs have a range of options for raising money beyond traditional financing. One such option is factoring, under which a business sells its invoices to financial institutions (the factor) at a discount for immediate cash. It is one of the best ways to improve the business's immediate term cash flow.

The Steps Involved in Factoring

  • The first step is to approach Banks or Factoring Houses to obtain a Factoring Credit facility. The financial institutions will take into consideration: 1) the Borrowers’ (the SMEs’) financial strength, 2) the Borrowers’ business nature, 3) the Borrowers’ clientele and accounts receivables aging report and other support factors related to the business.

  • Upon satisfaction of their due diligence, a Factoring facility will be granted by the financial institutions.

  • As the first step, the SME will sell its products or services to its customers and issue an invoice, which will involve a typical sales credit terms that the SME grants to its clients.

  • Second, the factor will review and approve the customer’s credit rating.

  • Third, the SME will send the factor a copy of its invoices which will be verified by the factor with the customer.

  • Fourth, the factor will advance 75-80% of the value of the invoices to the SME and hold 20-25% in reserve.

  • Fifth, the factor will collect payments on the invoices from the customer. Finally, the factor will return the remaining 20-25% of balance to the SME, after deducting about 1-4% in fees.
Types of Factoring

There are two main types of factoring services:

Recourse Factoring: In this type, the factor requires the SME to provide a refund on any invoices that remain unpaid or are delinquent.

Nonrecourse Factoring: The factor takes on the risk of invoices that may remain unpaid, often packaging at the back end with a trade credit insurer such as Euler Hermes Due to the high risk on the factor, the rates for this type of factoring tend to be more expensive. The factor will also be more diligent in checking the creditworthiness of the SME’s client roster.

There are other subcategories of factoring depending on the specific business needs of the SME.

Advance Factoring: Under advance factoring, the factor makes an immediate payment of the entire value of the invoices.

Non-Notified Factoring: In this category of factoring, the agreement between the factor and the SME is left undisclosed to the customers and the client collects bills from the customers without letting the latter know of the factoring arrangement.

Notified Factoring: This is the reverse of Non-Notified Factoring, in this case the customers of the SME are aware of the financing arrangement with the factor. Under this type of factoring, the factor manages the customer payment schedule along with invoices and customer credit. The factor and the SME agree on a date upon which the factor will pay the SME. This method of factoring gives more control of accounts receivable to the factor.

Bulk Factoring: Under this type of factoring, the SME receives financing based on the total value of its accounts receivable based on its account receivables aging report. The SME will receive financing from the factor but maintain control of all of its operations based on accounts receivable.

Cash flow is King Factoring for SMEs in Singapore

Qualifying for Factoring

Whether an SME qualifies for the services of a factor depends on the creditworthiness of its customers and its spread of debtors.  Factoring companies prefer SMEs to have a group of diverse customers (debtors) due to the greater spread of risk. Factoring companies conduct detailed due diligence of the customers of the SME depending on whether there is only one customer or a group of customers who have not paid up their invoices in full. The due diligence procedures and credit evaluation of individual customerss is less extensive in the case of a group of diverse buyers because of the spread of risk.

Additionally, the factoring company will also look at the track record of SMEs. SMEs should have been established for at least a year and their relationships with their customers should not be less than 6 months old.  This requirement may differ slightly based on the requirements of the individual factoring provider.

Advantages of Factoring

There are various advantages to factoring for SMEs, which give the SME more resources and time to focus on growing the business.

Debt Avoidance: First, factoring isn’t a loan or a debt (in structures of Non-Recourse Factoring), which means that SMEs will not be taking on additional debt burden. Also, factoring does not require SMEs to have extensive tangible assets or particularly strong financial credentials, which can be lifesaving for SMEs that don’t meet the strict financial credentials required by banks.

Immediate Cash Flow: Second, factoring provides SMEs with immediate cash flow to meet their obligations and grow their business. Cash flow is king for any business, and this is true for SMEs. With factoring cash on hand, SMEs will be able to fulfil their financial obligations like payroll and tax. They will also be able to go after opportunities such as buying additional contracts in order to grow their business.

Debt Collection: Third, since the factor buys the accounts receivable from the SME, it takes over the debt collection process for payments that are owed (in cases of Notified Structures) . This means that the factor will be responsible for credit checks on customers and other debt collection efforts. This reduces collection costs for the SME.

Risks in Factoring

There are also risks to factoring. One of the main risks of factoring is that the factoring fees could add up and become more expensive than traditional lending. Factoring is more beneficial to SMEs with a reliable client base. It is not beneficial for SMEs that may be in financial trouble. If the company’s accounts payable are substantially larger than their accounts receivable, they should look beyond factoring for financing options.

Continued Financing

Like all business relationships, the factoring relationship grows with sales. Since financing is based on the debt owed by customers, SMEs will get access to more factoring cash depending on the ability of their customers to pay on their obligations. More paying customers will lead to more factoring cash. This will ensure that the finances remain healthy and that there is enough to invest in customer acquisition, sales or even growing the size of the SME.

Factoring providers in Singapore

Almost all major banks in Singapore offer factoring services. The major factoring providers in Singapore include: Bibby Financial Services (Singapore), Capital Match Platform Pte. Ltd., First Trade Factoring Pte. Ltd., Global Merchant Funding Pte. Ltd., Hong Leong Finance Limited, IFS Capital Limited, and Malayan Banking Berhad.  Before approaching these banks, it would do you well to approach professional corporate service providers or credit consultancies for advice on how best to present your intended course of action to the banks for the best results. In some cases, these credit consultancies and corporate service providers have long-standing relationships with the banks and can probably increase your chances of persuading the bank to be your SMEs factor.

Last Modified Date: 29 Mar 2018