Contemporary Logistics. Two-factor Export Factoring: Optimal Option for Export-oriented SMEs Financing

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1 Contemporary Logistics 06 (2012) X Contents lists available at SEI Contemporary Logistics Journal homepage: Two-factor Export Factoring: Optimal Option for Export-oriented SMEs Financing Mingying GENG 1,*, Xiaoyu GENG 2 1. International Business Economic College, Wuhan Textile University, Wuhan , P.R. China 2. School of Economics & Management, Wuhan University, Wuhan , P.R. China K E Y W O R D S A B S T R A C T Two-factor export factoring, Export-oriented SMEs, Financing In the post-crisis era, increasing competition in international trade and non-credit settlements like charge sales festering the financial difficulties and foreign exchange risks to export-oriented SMEs. As an integrated financial service, Dual Export Factoring has rapidly developed in worldwide and has been the optimal choice of financing for Chinese export-oriented SMEs due to its unique advantages in export financing and risk-averse. This report analyses the function of Dual Export Factoring in export enhancement, and provides suggestions on its scientific appliance to enterprises. ST. PLUM-BLOSSOM PRESS PTY LTD 1 Introduction During the post-crisis era, the competition in international trade is becoming increasingly intensified. Buyers market occupies the leading position. The variety of flexible transaction means on credit (such as an account sale) is gradually replacing the traditional payment methods (L/C), and become the more competitive prevailing model. According to statistics, the account sales cover about 70% of the global trade at present, which is the most favorable for buyers as well as the most attractive trade methods. However, while it promotes the business transactions, account sales are bringing about new challenges for exporters, which are the security of receivables and pressure from financing. Among the Chinese export-oriented enterprises, especially the export-oriented SMEs, as they do not reach the financial standard, they are troubled by the financial matters. On one hand, in order to keep the business relations with importers and exports one after another, and have to accept O/A or D/A to get orders; on the other hand, exports are very worried about bad debts caused by it, which will bring losses and inevitably tight turnover of working capital. Facing all these difficulties, Two-Factor Export Factoring will be undoubtedly the best option for export-oriented SMEs, which can deal with the financing issues as well as risks in exchange rate and buyers credit. Two - Factor Export Factoring is one of the main function modes of international factoring business, which means when exporters sell goods to debtors (importers) by O/A and D/A, both the domestic export factoring agent and overseas import factoring agent provide exporters with a complete financial services which integrate trade financing, accounting management, receivables on call, credit risks control and bad debt guarantee. It mainly includes the following: 1 Advance funds. When export provides documents, factoring agent will offer trade financing by advancing funds (usually 80%). 2 Factoring agent takes risks in financial credit. After exporter sells documents to factoring agent, it is at agent s own risks. Even if the foreign importer dishonors or delays in payment, * Corresponding author. English edition copyright ST. PLUM-BLOSSOM PRESS PTY LTD DOI: /J.CL

2 agent has no recourse to exporter. 3 It is a complete business. Those exporters who sell accounts receivable are usually SMEs, they are not familiar with international market. The two factoring agents represent exporter to conduct the credit investigation, and undertake collection, receivables on call as well as accounting business. 4 Factoring business is a mature means of account settlement. As well as solving the issues in funds security and enterprises financing, it has globally unprecedented developing momentum. According to the statistics from Factors Chain International (FCI), the global factoring business volume is 1300 billion Euro dollars in In 2008, it reaches 1325 billion Euro dollars. In 2009, as the global financial crisis, the global trade was affected. Hence, it resulted in the decrease of factoring business which is 1284 billion Euro dollars. As to the statistics from World Bank, the percentage of global factoring business in GDP has exceeded 3%. In European developed countries, it is more than 10%. Compared with developed countries, China s factoring business is still at the starting phase. In 2005, China s factoring business volume is 5.8 billion Euro dollars, which only covers 0.33% of its GDP. In 2008 it reached 1.77%. But it lagged behind too much as the second largest trade country in the world. As it shows in Chart1, China s factoring business is increasing year by year from 2003 to In year 2010, China was ranked 5 among the top 10 countries in the world trade. Although 16 domestic banks joined FCI, most focus on the large scale enterprises. They set high threshold in financing for SMEs. Therefore, it is said that factoring was born for SMEs, but difficult for SMEs to use. As China s export volume is large, there is a potential market for factoring business in China. As the authority forecasted that in the next decade, factoring will develop dramatically and form a new emerging industry with annual volume of 100 billion US dollars. Table 1 TOP 10 countries in world trade in 2010 and its factoring business total in recent eight years(unit: Million Euro) Time Country USA 80,696 81,860 94,160 96,000 97, ,000 88,500 95,000 China 2,640 4,315 5,830 14,300 32,976 55,000 67, ,890 Germany 35,082 45,000 55,110 72,000 89, ,000 96, ,536 Japan 60,550 72,535 77,220 74,530 77, ,500 83,700 98,500 France 73,200 81,600 89, , , , , ,252 Netherlands 17,500 19,600 23,300 25,500 31,820 30,000 30,000 35,000 U.K. 160, , , , , , , ,243 Italy 132, , , , , , , ,745 Belgium 11,500 13,500 14,000 16,700 19,200 22,500 23,921 32,203 Canada 3,161 3,157 3,820 3,386 4,270 3,000 3,250 3,723 Source: International Factoring Volume Data in Recent 8 Years from FCI (http://www.factors-chain.com) 2 Challenges for China s SMEs in Post-Crisis Era The negative influence of financial crisis on the world trade still continuing. With the internal and external worsen environment, China s SMEs are facing the following challenges in export: 2.1 Tight funds and difficulty in financing Line of credit and liquidity shortfall are always difficulty for SMEs. Generally speaking, enterprises are always demanders for funds. It is especially obvious during the financial crisis. Although there is a package scheme of 4000 billion RMB in China to stimulate economy recovery, the Matthew effect works and most of the funds will invest in large scale program and large scale enterprises. It is difficult for SMEs in financing. In 2009, China raised export rebate rate for several items. As the long process of export rebate, it caused difficulty for exporters in financial turnover. 2.2 Importer s credit risks increasing Credit risk of business partner is the main concern for SMEs. During the financial crisis, many overseas importers went bankrupt, it led to the rapid increasing of bad debts. As the limited scale and strength of the export-oriented SMEs, they cannot make the credit investigation of foreign importers themselves. Information asymmetry causes mistrust of importers and they are afraid to take orders. Therefore, it is difficult to develop the market for export. 2.3 Risk in settlement increased Attached by the financial crisis, there is much more keen competition in international market. O/A and D/A replace the traditional payment method L/C and became the mainstream in the market of developed countries. It increases the risks in settlement for SMEs. 87

3 Considering security of exchange collection, many export-oriented SMEs only accept L/C and lost market opportunity. 2.4 Overseas orders decreasing During the crisis, purchasing power of residents is going down in all the countries, but their desire for saving is strengthened. It reduced the demands for foreign products. The market of SMEs is mainly for unnecessary. After the crisis, importers of developed countries compressed the imports. Actually as the result of the decreased demand for unnecessary, overseas orders are decreasing to some extent. With the lack of capacity in market development, prospects of export for SMEs are not optimistic. 2.5 RMB appreciating RMB is appreciating with China s rapid development in economy, increasing trade volume and substantive foreign exchange reverse. The survey of Reuters shows that at the end of 2010, exchange rate of RMB and USD will rise by 2% to 3%. It is another appreciation since RMB exchange rate reform in July 2005, and it is expected to go up by 2% annually in later years. The continuous appreciation of RMB will reduce the revenue of export-oriented enterprises, enlarge the business risks. The price of raw materials for export products will go up further and so does the labor cost does the labor cost. Therefore, the profit of export - oriented SMEs more and more meager. 3 Export Promotions for SMEs Made by Two-factor Export Factoring Service Normally, most of the commodities exported by the SMEs are those with small money amount and are in many batches like garments, knitted textile goods, shoes and other nondurable consumer goods. All these goods shipments should be split for many times with small amount in each shipment. If adopting L/C, formalities are trivial and funds are tied up. But export dual factoring service has a comprehensive financing function, which can promote the export of SMEs at various levels. 3.1 SMEs can gain flexible trade financing by using the export dual factoring service If the SMEs have signed up with the factor the factoring agreements without recourse, when the exporter has shipped the goods, they can sell the invoices of receivables to the factor or the commercial bank and get 80% of the financing funds without any guarantee or pledge. The payment term can be 60 to 180 days, which can solve the problem of insufficient cash flow caused by the credit sale, speed up the capital turnover and make up the working capital. Under the current situation, necessary funds support can save the enterprises from the loss of bad debts in the financial crisis for better international trading. 3.2 SMEs can avoid the risk of exchange collection and exchange rate fluctuation by using the export dual factoring service Recourse-free is an important financing characteristic of factoring service, which means that when the factoring agreement is signed up, the receivables will have no recourse as the receivables of the exporter have been bought by the factor or the commercial bank. Even when the buyer cannot pay due to the bankruptcy, bad capital turnover or foreign exchange control, the commercial bank cannot have recourse to the buyer. That means SMEs transfer the risk of not being capable of receiving payment to the factor and the factor take the risk of credit financing. Meanwhile, with the help from the factor members of FCI in the world, namely, their independent and professional suggestions made by their knowledge, methods, analysis about the credit standing of the exporter in the local market, and the check of buyer s credit volume, the receivables of the exporter can be well guaranteed. 3.3 SMEs can optimize the financial statement and save the trading cost by using the export dual factoring service If the enterprises do financing by using the bank loans and debt will be shown in the financial statement. However, if they do financing by using the factoring service, the debt will not be increased while the cash flow will be increased, which will help the listed SMEs to lower the asset-liability ratio, optimize the financial statement, and help the enterprises financing successfully again. At the same time, the factoring service is an all-round financial service targeting at the export-oriented SMEs, the factor is responsible for collecting the receivables and managing the sales accounts, which ease the burden of the exporter and save the costs of financial management. And the factor can bear loss even when the bad debts happen. Therefore, the waste of human resources and financial resources in chasing the receivables can be avoided. 4 Notices for SMEs in Using Export Dual Factoring Service for Financing Like the export credit insurance, the export dual factoring is also a method helping the export-oriented enterprises to deal with the safe collection of foreign exchange and the fund embezzlement. However, a growing number of enterprises in China start to use export credit insurance while many enterprises especially the export-oriented SMEs don t know about the export factoring service. Although the export factoring service is mainly designed for SMEs, it has innovation and is a service with high technology and 88

4 operation risks. Therefore, when using the service, we should know its basic characteristic and put the advantage of the factoring service into full play to promote the development of export trade of SMEs. To be specific, the points as follows should be put into consideration. 4.1 The export dual factoring service is suitable for the commodities and services which have short account closing period, simple trading conditions and contracts, plus, both the seller and buyer can easily reach a consensus on the quality of commodities The export product structure of SMEs is mainly the consumer goods which are in small amount and in many batches like garments, knitted textile goods, shoes, small household appliances, toys and stationary sports goods, etc. All these products can be sold in the stores for the import countries, the importer and exporter can easily reach a consensus on the quality of the products, and the trade disputes can hardly triggered. But for the large capital-oriented mechanical and electrical products and equipments, the factoring service is not suitable, in contrast the export credit insurance or L/C can be adopted. 4.2 The export factoring service is targeting at the account closing ways of credit sale and D/A, And the sales based on L/C (not including standby L/C), cash against shipping documents or any other cash transaction are the exception As the trade forms solely based on the commercial credit, credit sale and D/A will bring about high risks for the SMEs, whether they can get the payment or not solely depend on the commercial credit of the importer. But when the factors intervene, this commercial credit can be developed into the factor credit which lies between the commercial credit and the bank credit which can contribute to the expansion of international trade. If the importer insists on the factoring payment in trade, the exporter can consider adopting it if there is an appropriate factor. 4.3 Choose appropriate export factoring and export credit insurance Because the risk of export trade under the way of credit sale is increasing, many export-oriented enterprises tend to choose credit insurance. Until December , China s short-term export credit insurance exceeded 84 billion USD, which doubles the figure last year 30 billion USD, but the factoring business in the same period hasn t gained so much growth. Table 2 shows that the export factoring was weak in only two areas compared to the export credit insurance; one is that the export credit insurance guaranteed by the state has strong capability of coping with risks, but FCI can make detailed investigation about the credit of enterprises to lower the risks. The other one is that although the export credit insurance can apply to all the countries, the main trade partners of China s SMEs are from developed counties in EU and US, so the SMEs should choose export factoring service when trading with EU and US. If they want to explore the new market, they can choose the export credit insurance as well to lower the exchange collection risk. Table 2 Differences between the export factoring and export credit insurance The Compens Remit Credit Compensa highest Pay in Collection ation Account Assess tion credit Advance Account Duration Warranty ment Procedure insurance Risk-withs tanding Ability For Export Factoring 100% Yes 90 Days Yes Yes Yes Easy Medium Strong Developed Export Credit Insurance Complicat 70-90% No Yes Yes No Days ed Strong All 5 Conclusion According to the analysis above, SMEs are facing to the financial difficulty and the security problem of receivables in the trend of buyer s market in the international trade. In the closing trend of international account, international factoring service has become a major method to close the account and do financing. And the export dual factoring service can solve the financial difficulty for SMEs, and can ease many receivables as well, which is able to promote the export of SMEs at various levels. Therefore, the export-oriented SMEs in China should play an active role in understanding, applying and adapting to the factoring service to solve the problems in trade to better explore the international market, especially the market in developed countries. 89

5 References [1]. GENERAL RULES FOR INTERNATIONAL FACTORING (2003), id=1700 [2]. Assoc. International Factoring Available Financing Solution for Firms [J]. The Young Economists Journal (1), p27-34 [3]. Ray Pereira. International Factoring. [4]. XIAO Chaoqing. International factoring [M]. Beijing: China Commerce and Trade Press, 2004, p (In Chinese) [5]. XIAO Xiaolin. A Research on SMES Factoring Financing in our Country Under Financial Crisis [J]. Commercial Bank Management, 2010 (3), p45-49 (In Chinese) 90

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