Leasing and Factoring for SME Finance

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1 Leasing and Factoring for SME Finance ADBI Seminar on SME Finance May 2006 Yasuo IZUMI 1 The v iews expressed in this paper are the v iews of the author and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian Dev elopment Bank (ADB), or its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.

2 Table of Contents I. Leasing / II. Factoring Definition and Structure Comparison with Other Instruments Advantages and Disadvantages Promoting Lease / Factoring Legal Framework + Conclusion and Recommendations 2

3 I. Leasing (Financial Lease) 3

4 Capital Investment for Growth Fixed Capital Investment (Capex) - an Essential Factor for a Sustainable and Medium-term Growth of Economy Issues - Shallow and Weak Banking System - Lack of L/T Institutional Investors - L/T Funding Source - Non-Existent 4

5 SMEs and Capex SMEs Key Driving Force of Growth and Need Fixed Capital Investment Issues - SMEs are Poorly Treated by Banking Sector - Virtually No Possibility to Get a L/T Loan Due mainly to a) less disclosed financial statements b) poor credit history, and c) lack of collaterals against new loan 5

6 Lease 1. Definition A Medium-term Financial Instrument Contracted between Asset Owner (Lessor) and Asset User (Lessee) During a Given Period (Economic Life) Lessee Pays Rental for Usage of Asset Lessee may Exercise Option to Purchase Assets at Residual Value 6

7 Lease 2. Notion of Lease Profits are Generated by Usage of Asset NOT from the Value / Ownership of Asset Generated Cash-flow from Leased Asset Covers Lease Payment Collateral does NOT Value Asset Productivity 7

8 Lease 3. Structure 1. Apply Lease Lessor 5. Lease Equipment 6. Pay Lease Rental Lessee 2. Give Funding 7. Repayment 3. Purchase Equipment 5. Lease Equipment 4. Supply Equipment Financier Supplier 8

9 Lease 4. Comparison 1/2 Financial Lease vs. Operating Lease Asset Ownership - Fin. Lease - Transferred to Lessee at the End - Ope. Lease - Remains at Lessor Lease Term - Fin. Lease Economic Life of Asset - Ope. Lease Can be a Short Period 9

10 Lease 5. Comparison 2/2 Financial Lease vs. Bank Loan Ownership of Asset - Fin. Lease Belongs to Lessor (not Company or Lessee) - Bank Loan Borrowing Company 10

11 Lease 6. Advantages (Lessee) Leasing can be the Only Available Source of M/T Finance in Developing Countries Leasing can be Arranged more Easily Not requiring collateral arrangement 11

12 Lease 7. Advantages (Lessor) Lessor is Ensured Asset in Question is Purchased - Lessee NOT able to Use Proceeds for Other Purposes Lease Documentation is Simpler, thus Keep Transaction Costs Low Leasing Companies, not under Bank Regulation, Seek Higher Freedom 12

13 Lease 8. Promotion Suitable in Countries where: - Business Environment is Weak, - Creditor s Right are less Protected, - Collateral System is not Functioning, or - Asset Registry System is not well Managed 13

14 Lease 9. Legal Environment Legislation covering Leasing Operations may Cover: - Clear Definition of Leasing - Lessor s Ownership of Leased Assets - Assurance for Third Party to have Security on Leased Asset - Lessor s Right to Take Possessions when Lessee in Default 14

15 Lease 10. Accounting Accounting Framework should be Established on IAS-17 Basis - Recording of Leased Asset - Depreciate the Asset - Accounting Entries based on Economic Substance 15

16 Lease 11. Conclusion Lease can be a Valuable Additional Source of M/T Finance, Not often Available Particularly Suitable for SMEs not able to Receive Bank Loans 16

17 II. Factoring 17

18 Working Capital Working Capital Funding is Vital and Key of Dynamic Economy SMEs are always Difficult to Get Enough Funding - Lack of Assets to be Collateralized 18

19 Account Receivables Most Popular Asset Item Converting Account Receivables (A/R), Often in the Form of an Invoice, into a Legally Supported Financial Tool, called Factoring 19

20 Factoring 1. Definition A Type of Supplier Financing Companies Sell A/R to Factor and Receive Cash Factor Collect A/R by Due Date 20

21 Factoring 2. Structure Factor 4. Payment Obligation Buyer 2. Account Receivables 3. Cash Seller 1. Sale of Goods 21

22 Factoring 3. Comparison Working Capital Funding - Factoring Sell A/R, Receive Cash - Bank Loan Collateral Needed Creditworthiness - Factor Look at Buyers Credibility - Banker Borrower and its Collateral 22

23 Factoring 4. Advantages Suitable for Countries: - Financial System is Weak - Commercial Law and Enforcement is Poor Fit to Finance to High Risk Borrowers like SMEs - Factoring is based on Risks of A/R 23

24 Factoring 5. Conclusion Factoring is Suitable Financial Tool Providing Working Capital Funding for SMEs Account Receivables are Representing Risks of Buyers Credibility, Quite Often Large Buyers Reverse Factoring Initiated by Large Buyers has been Growing Fast 24

25 End of Presentation Yasuo IZUMI Advisor, Sr. Consultant IC Net Limited 25

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