International trade offers remunerative opportunities to the traders but also demands resilience and strategically planned execution from them. Out of a multitude of stumbling blocks that exporters face, procuring finance and mitigating payment risks are the most cumbersome for them.
According to a trade and finance report in 2016 by the ICC, almost 80% of the global trade functions with the strong support of export finance. Exporters, until now, have always been dependent on the traditional export credit methods extended to them by the banks, private financial institutions, and government agencies for their short-term, medium-term and long-term needs, against collateral or assets.
What is the export credit?
Financial loan acquired by the exporters through banks or financial institutions against collateral or security has always been the prevalent methods of procuring export credit.
Lack of assets or collateral to be presented to the banks as security to procure credit by the small companies gradually made way for a relatively newer method of accessing financial support. This method is known as export factoring.
Though it is yet to be accepted by the Indian exporters without apprehensions, it is undoubtedly gaining momentum around several countries in the world as a complete financial package.
What is export factoring?
Export factoring is a tool, which enables the exporters to procure short-term financial assistance against the bills of exchange, to be received by them, under open account payment terms from the importer, after they have delivered the goods.
It is not a pre-shipment but post-shipment finance for the exporter. And the factors contributing credit cover three services under it, i.e., finance, credit protection, and follow-up services.
Critical factors of export factoring:
- A tool to raise short-term finance
- A seller sells his receivables to a factor for immediate cash
- After deduction of the fees and charges the exporter receives up to 90% of total receivables immediately once the factor approves the papers, the rest of the amount goes through clearance once the shipment is complete to the satisfaction of both parties.
- The credit is an open account receivables system and can extend beyond six months.
How to qualify for export factoring?
There are no qualification criteria for export factoring. First-time exporters or SMEs can avail export factoring without any cumbersome documentation process, yet there are certain criteria that exporters applying for export factoring should meet –
- The factor considers the importer’s credibility with whom the exporter is dealing.
- No bank has secured the accounts receivable.
- The payment terms are under open account credit term.
- There is a valid contract between the buyer and the exporter.
- The seller sells his receivable to a third party, i.e. the factor
An exporter dealing in gems and jewelry cannot opt for export factoring, as these items are not amenable to factoring. The exporters mandatorily have to share each detail regarding the agreement, debtor, sales agreement, the term of payments and the exporter’s performance history to acquire financial assistance through export factoring.
How is export factoring different from traditional export credit?
Traditional export credit is not available without collateral or security whereas the only major requirement under export factoring is a valid agreement between the exporter and the importer under open account payment terms.
Banks or financial institutions under the traditional export credit do not provide credit protection, collection facility or unsecured finance to the exporters, unlike export factoring.
Unlike the traditional methods of procuring credit, finance is available in the invoice currency and is actually cheaper for the Indian companies as the interest rate is based on London Inter-Bank Offered Rate, i.e. LIBOR, which is significantly lower than the Indian interest rates.
Factoring, however, is not a replacement to procuring finance through banks but instead acts as a supplementary method to garner working capital.
When taking credit through traditional export credit methods, the exporters have to protect themselves against importers default by taking an insurance cover from an agency. It involves cumbersome documentation process for two separate institutions whereas export factoring provides a complete financial package to the exporters.
Why is export factoring a preferred choice?
Export factoring presently is a recognized and accepted method of open account receivables financing all across the globe. A systemic and methodical set of rules and procedures is applicable for governing it. It assists exporters to avoid credit losses by mitigating their collection and credit risks to a third party.
There are several reasons why export factoring is gradually becoming a preferred choice of procuring short-term finance all around the globe. These reasons include –
- Elimination of the risk of non-payment as it is against accounts receivable.
- It helps exporter to avail immediate cash.
- It charges interest only against the funds provided. There are no hidden costs.
- Operating costs become minimal as the factor takes over the risk of collection debts
- It is not a kind of credit instead is an advance against the bills receivable
- Immediate liquid cash becomes available within 24 hours against presentation of accounts receivable
- Does not require any assurance from any bank or other financial institution
- It does not put the financial burden on the exporters like traditional financing methods.
- The process of procuring credit guarantee through export factoring is straightforward and simple
- It enables the exporter to cover his payment risk and have adequate cash flow
- It assists those small exporters or MSMEs that do not have the back up of assets to procure immediate cash without any collateral security
Export factoring in India
Export factoring in India has still to gain recognition. Some exporters are unaware of it being a method to procure cash against accounts receivable. Some are apprehensive about its process and its expenses. According to estimates, there are only 30 to 35% exporters in India who are aware of export factoring. Countries like China, Germany, France, Brazil, Taiwan, and Italy have well recognized the advantages of export factoring. Though, it still has to be accepted by the Indian exporters.
India presently has seven institutions that are members of FCI [Factors Chain International], the global association for providing factoring services. Germany has 190 such institutions, yet India is poised to take off on it.
Trade finance is an integral part of international trade. Thus, export factoring has emerged to be the most lucrative alternate for exporters. It is for those who want to avail liquid cash, an advance against their invoice without any risk.