Li Li [2], Geng Wei [3] Business School, Nankai University, P.R.China,

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1 The Study of International Factoring Business in the Process of Financing at the Front End of Supply Chain [1] Based on Chinese Small and Medium-sized Export Manufactures Li Li [2], Geng Wei [3] Business School, Nankai University, P.R.China, Abstract: Based on the background of economic globalization, the development of global supply chain and the opening of entire Chinese money market, the thesis chooses Chinese small and medium-sized export manufactures as its object. By analyzing from the theory and the practice, the thesis studies how to apply the innovative re-compounding of finance products to the financing process of Chinese small and medium-sized export manufacturers, who are in the inferior position in the whole supply chain, discusses how to take advantages of the financing functions of international factoring at the front end of supply chain to solve the problems that Chinese small and medium-sized export manufacturers are not able to develop manufacturing smoothly because of capital shortage after they get international orders. Key words: international factoring; small and medium-sized export manufactures; the front end of supply chain 1 Introduction As logistics is more and more well-known, the efficiency of material flow and information flow has been greatly improved and the supply chain has quickly developed. In the field of global supply chain, the enterprises in the leading position in the supply chain are always those Multinational Corporation with ample capital, whose suppliers and distributors, scattered in different countries and territories all over the world, are in the inferior position in the supply chain. At present, global manufacturing and purchasing business has been transferred to China and Chinese manufactures have played an important role in the global manufacturing. In order to increase export and occupy the international market, those small and medium-sized export manufactures in China which are in the inferior position, put more attention to supplying competitive trading condition to buyers, besides better quality or lower price. However, in the O/A pattern, on one hand, exporters capital turnover rate is decreased as most capital is occupied; on the other hand, exporters may get many bad debts, because they have to take the risk of credits of the buyers. Therefore, there is an urgency to solve the problems of how to make those small and medium-sized export manufactures in China take a competitive position and solve the problem of financing and keeping away the risks among the theorists and businessmen. The purpose of finance study of supply chain is to introduce capital flow into global supply chain, which supplies the capital for the enterprises in the supply chain, as well as supplies a new method of credit financing for those uncompetitive companies. In the western study and the famous commercial banks study, it is called financial supply chain management (FSCM), while in domestic study, it is divided into logistic finance and trading finance. Among the theory results of logistic finance, the majority of the theories, which re-compound the [1] The study is sponsored by the funds as follows: 1. A key project of National natural science funds, No Asia and the Pacific center of Nankai University, Korean higher education consortium, No. AS Nankai university social science funds [2] Li Li (1961- ), female, Tianjin, Financial Management, Business School, Nankai University, Professor, vice-director of MPAcc; research field: financial management, logistics management, financial analysis. [3] Geng Wei (1978- ), male, Shandong, MBA, Business School, Nankai University; majority: financial management, logistics management. 544

2 present finance products and, are based on the business in banks and logistic companies. However, as for the legislation limitation in China, logistic companies are not qualified to run finance business. Therefore, many studies are just theories that are difficult to apply to real business. And the study of international factoring has occurred in the field of commerce finance business, but because domestic factoring businesses are run only by banks, with the limitation of various regulation of the domestic banks, the advantages of factoring business can not be developed entirely. With the further development of the domestic finance market, the professional factoring company has occurred in China, and the condition of restudying the application of factoring business in supply chain has formed. Factoring is a new comprehensive finance business including commerce financing, credit survey, receivables administration and credit risk guarantee. It refers to a finance business in which the seller (the exporter) sells his receivables to the factor who will press for the receivables. We can divide the factoring business into domestic factoring and international factoring according to whether the supplier and the buyer being in the same country or territory. In international factoring, the domestic factor asks the factor in the corresponding country to convey the credit of the buyer and give according to the order between the exporter and overseas buyer through international factoring organization. The domestic factor buys the receivables of the seller, and granting financing to the seller in advance in his bound, and then press for the receivables. As the domestic enterprise credit system has not been built, it would be difficult to develop domestic factoring business, and the thesis will discuss the international factoring business with the supplier in China and the buyer abroad. The traditional factoring business serves at the back end of the supply chain as the trade-finance products, i.e. it provides agent-service to resolve the problems about finance and risk when settling the sale amount after producing and processing been finished. As we known, at the front end of the supply chain, most of Chinese small and medium-size export manufacturers are unable to accept orders continuously just because the importers always take use of O/A (open-account) method to settle the former orders so that the exporters have no money to enlarge the scale of production. This thesis tries to study how to resolve the problem above with completely taking advantages of finance functions of factoring business. 2 Current Development and Trend of the Factoring in China and Abroad 2.1 Current Development of Global Factoring Since 1960s, factoring business has got great development according to the statistic by FCI(Factors Chain International),the gross revenue of factoring has reached to billion Euro dollar (equal to billion USD). Viewed in the term of factoring type, domestic factoring earning has been upto 930 billion EU dollars, 86.5 billion for international factoring. From table 1, we could see factoring has developed very rapidly in the past few years. Global revenue has increased by 83 % than that in Among the markets of factoring in different area, the EU market is the most mature one which shared 71% of total market in US and Japan have developed mature market comparatively, 9% market share for US, 7 %for Japan. If we see factoring from the range of goods, the service object of factoring has expanded from normal consumptive goods to capital goods, including workshop, equipment and machinery. In the aspect of service method, factoring has an obvious trend of modifying IT technology and applying IT widely into the factoring industry.. At present, FCI and IFG are main global organizations with great influence, which have 290 members distributed in 61 countries and areas. Some of these members are world famous bankers, multinational corporations and factoring companies attached to financial sectors. 545

3 Table 1: Statistics of factoring revenue in the main market in the past 7 years. Unit: Million Euro country year France 53,100 52,450 67,660 67,398 73,200 81,600 89,020 Germany 19,984 23,483 29,373 30,156 35,082 45,000 55,110 Italy 88, , , , , , ,175 England 103, , , , , , ,205 Europe sub-amount 352, , , , , , ,486 Brazil 17,010 12,012 11,020 11,030 12,040 15,500 20,050 Mexico 3,550 5,030 6,890 6,340 4,535 4,600 7,100 USA 88, , ,744 91,143 80,696 81,860 94,160 America sub-amount 115, , , , , , ,630 Hongkong 1,800 2,400 2,690 3,029 3,250 4,800 7,700 Japan 55,347 58,473 61,565 50,380 60,550 72,535 77,220 Taiwan 2,090 3,650 4,511 7,919 16,000 23,000 36,000 China ,234 2,077 2,640 4,315 5,830 Asia 78,775 69,865 76,078 69,850 89, , ,814 Total amount 556, , , , , ,215 1,016,547 material recourse:fci : Current status of domestic factoring and problems History and current condition in factoring International factoring has a late start and low rate development. From the beginning, im-export enterprises settled by L/C, remittance. With development of our international trade, export enterprises increasingly acknowledge the advantage of factoring in international trade. In 1988, China Bank firstly developed international factoring. Till now, there have been 12 banks becoming FCI members, including four state-owned commercial banks, seven stock commercial banks and one foreign bank. In addition, professional international factoring companies have established belonging to IFG member in Tianjin. From the development of recent years, despite of big increase in international factoring, compared to over one thousand billion USD of trade volume and whole world factoring volume, the development is limited with large potential development range. Calculated by FCI, in 2005, our factoring volume is 5.83 billion Euro, thereinto domestic factoring is 4.15 billion, international factoring 1.68 billion Main problems in our factoring development Calculated from China Bank introducing factoring, our factoring has developed for 18 years, its volume has reached certain scale. However, from whole, factoring development is just in the very beginning. Compared to our economic scale and trade volume, our factoring is still in a very low level. In 2005, whole year volume occupies only 0.3% in GDP. Main problems in our factoring are as bellows. (1)Currently domestic factoring is managed by banks basically. But in specific practice, factoring is seen as bank business, its operation and valuation to domestic factoring client are similar to bank loan. Clients are always large and not small and middle enterprises. (2)Now international factoring has a low acceptance in China. Most of middle and small enterprises do not know factoring yet. In international trade in im-export enterprises, L/C is still the main settlement manner. (3)Many im-export companies set limitation to factoring. China still has many different scale trade 546

4 companies, which hold the purchasing information and orders of foreign companies, looking for factories and earning profit from business. Im-export trade companies in middle also set limitation to factoring. 3. Current condition analysis in financing of small and medium-sized export manufactures in China 3.1 Financing current condition of small and medium-sized export manufactures In 2005, our in-export trade has a continuous four-year high rate increasing with whole volume of 1.42 thousand billion USD, which increases by 23.2% to last year. Thereinto, export increaseds28.4%, import increases 17.6%. International trade volume is list as third safely. In commodity structure, export products are mainly centralized as industry finished products, especially light industry products and machines. In terms of trade mode, process trade surplus are much larger than normal trade surplus. In terms of domestic trade, foreign and collectivity-owned companies are development trends in current time and future. Two have occupies 74% in export and 69% in import, holding absolute preponderance position. Thereinto, foreign companies have strong industry international competition with international marketing net, hi-tech and modern management skills. In addition, with increasing development in international trade, collectivity-owned and private enterprises have a kind of special export impetus in short term. According to the survey, Chinese export enterprises are encountering difficulties in investment of land, building and equipment because of limited own money. The short of money limits next development in scale. So convenient financing becomes a key factor in deciding enterprise development and in-export business development. Generally, it s a popular phenomena in China that the export-oriented SMEs (small-medium-enterprises) are difficult to get sufficient financing, which resulted from the enterprises themselves, the banks policies, social environments, etc. Firstly, in respect of the enterprises, the Chinese export-oriented enterprises have some general disadvantages, such as small-scaled production entities, narrow information channels, weak abilities to solve risks, few kinds of products, lower technology components, and so on, which make them easily be impacted by the fierce competition in the overseas markets. On the other hand, the un- healthiness accounting systems, un-transparence financial information disclosed and un-standardization financial statements bring difficulties to the communication between banks and the enterprises, increase the loan risks and risk-control costs. In addition, since parts of import/export companies are new setups, they need much more financing support. But they seldom obtain enough bank facilities because of their nature of new entities: higher gearing ratio, weak profitability, inadequate cash flow, as well as poor capital structure, which could not be approved by banks credit committees. Secondly, in respect of the banks, along with the reform of state-owned commercial banks and market-driven reform of interest rate, commercial banks have to strengthen the credit control procedures and the internal accounting systems, slower down the credit approvals. The banks adopt the measures of collective management, collective operation to generally control the credit authorities, reduce the credit authorities from lower management levels, increase the procedures for credit applications, prolong the credit approval periods. The banks have connected each credit with its direct superintendent and will remain the resource right for all the time, which make the credit superintendent become more prudent to explore banking opportunities. Especially to import/export companies, the credit superintendents are always not active to touch in view that they are not familiar with international credit products and could not be as active as before. Thirdly, in respect of the social environments, commercial banks have to pay more attention to the credit risks because of the poor credit environments. For the time being, it s not difficult to see that some companies or individuals default the bank debts with certain purpose. If it is the case, commercial banks usually could not get back the loan principals, so that deteriorated the relationship between the banks and the borrowers and impacted the banks issuance of loans. 3.2 Typical International Trade Financing on the Supply Chain 547

5 Supply chain means based on the buyer s demand, then forms a network, covering various manufacturing and commercial activities, such as designing the product, supplying raw materials, manufacturing and processing, wholesaling, retailing, and then delivering the product to the end-user. In recent years, because of large scaled enterprises exhibited their strong focuses on the supply chains, the status of supply chain is more important day by day. While, large-scaled enterprises requests for zero-stock transfer a relative part of management costs and funding costs to their up-stream or down-stream companies, which bring out the financing issues to those SMEs. The financing issues also revert to large-scaled enterprises by destroy the stability of supply chain so as to plant potentials for their normal operations. International trade financing means based on the bank credit of importers and exporters as well as the international trade background, the banks provide short term or medium term facilities to importers/exports/corresponding banks to finance the international trade businesses. It has the characteristics of lower risks, shorter periods, stronger repayment abilities, trade background, etc. Therefore, the research for renovating the financing products so as to provide trade financing to small-medium-scales companies on the supply chains becomes so much significant to export-oriented companies in China. Let s take a look of Template One. We find that typical supply chain may create financing needs from three respects: Cash in advance, Account receivable and Inventory. The introductions of these financial products as follows: 1. Financing from Cash in advance. This means companies may collect cash in advance from the buyers to create a short term cash inflow/financing. This method is based on the companies commercial credits. Funding cost is lower. Usually it s adopted in the long production cycle, higher selling price, highly demanded products. For instance, real estate developer often requires the resident/buyer to pay a certain percentage of the total selling amount in advance, so as to borrow money from the buyers to partially release the funding pressure. But this method is seldom applied by SMEs on the supply chain. 2. Logistical warehousing financing. This means companies pledge the inventories or the products in transit to the financial institutions to generate financing. At present, logistical warehousing financing could be divided into two categories. One is vertical credit-authorizing model. Commercial banks analyze the logistic companies business performances and grant credit facilities to those logistic companies. Logistic companies have to be responsible for the credit administration and risk control. Under this model, commercial banks may reduce their credit operating costs and transfer out the credit risks. The other one is inventories financing model. Commercial banks cooperate with logistic companies and jointly provide inventories financing to the companies. The banks must provide special service platform and management account to inventories financing, as well the credit risk evaluating abilities. Logistic companies provide logistical and information support to companies. 3. Account receivables financing. This means to obtain financing from financial institutions against account receivables, including two methods: 1) Pledge the account receivables. That is the Borrower pledges the account receivables to the bank to get financing in advance, and repay the bank once it 548

6 receives the payments; 2) Factoring. That is packing the account receivables to commercial banks or factoring agents to get financing and the borrower, meanwhile, give up the reimbursement rights. Template Two breaks down some common financing products on the supply chain: Common Financing Products on Supply Chain Financing Type Products/Models Remarks 1.Delivery against bills/payments Cash in advance Inventory Account receivables 2.Shipping Guarantee 3.Opening L/Cs on clean basis 4.discounting 1.movable assets impawn 2.Standard warehousing order pledge 3.import discounting 4.shipping guarantee 1.Transferring A/R to bills 2.factoring 3.export credit financing 4.packing loan 5.export bills discounting 6.forfeiting goods rights under L/Cs, usance L/Cs with payments at sight, transferable L/Cs, opening L/Cs against off-shore pledges movable, fixed discounting for banker s acceptance bills national factoring, international factoring 3.3 International factoring s advantages to export-oriented SMEs Account receivables financing (eg. Loan, packing loan, discounting, etc.) requires the borrowers to meet some criteria set up by the banks or the borrower s business should be based on L/Cs. These are usually hard for export-oriented SMEs to achive. Comparing to that, international factoring is more suitable to export-oriented SMEs. It provides a solution to the borrower s financing issue. Meanwhile, it can effectively reduce the bad debt ratio. Hence it s realistic for us to enlarge the export business. 1. Factoring is a special method for SME financing which in compliance with the commercial regulatory. Factoring focuses on the analysis of the cash flow projection instead of paying more attention to the company scale and/or sufficient mortgage, guarantee, etc, which is more applicable to the emerging SMEs. 2. Factoring may assist SMEs to effectively avoid the potential payment defaults from credit sales. In supply market, SMEs usually promote products by offering credits to buyers. Therefore, the opportunity cost increased, bad debt risks increased, management cost for account receivables also increased. In addition, the quality of account receivables is not satisfactory, which resulted in the large accumulated account receivables and destroyed the cash flow position, further impact the sustainability of business. Factoring covers the account receivables tracing, sales accounts management, bad debts guarantee, etc, solving a series of financing issues. 3. Factoring assists the supplier to survive from the credit sales. Besides products quality, pricing, after-sales services, through the favorable payment terms supplier can strengthen its core competence. 4. International factoring may push SMEs to enlarge the export business. International factoring adopts double factoring systems to dilute the exporter s confusion raised from the less understanding of foreign laws, customs, etc., to mitigate the credit risk for less understanding of the importer s credit and the foreign market, to shorten the collection period, to avoid the exchange rate risk, so as to improve the export business. Nowadays, factoring is acceptable to SMEs and has been listed into the opening projects in WTO Bilateral Agreement. 4 New research on Supply Chain Front End Financing by International Factoring 4.1 Background 549

7 In the supply chain, export-driven SMEs always need large working capital. Since the high demand in overseas markets and improved inventory management quality, the working capital is less utilized in inventory. Working capital needs often caused from purchasing raw materials, installing new equipments, expanding production capacity and account receivables often cause shortage of working capital It s popular that SMEs in china could not commit foreign orders because of shortage of working capital. Traditional factoring offers financing to the last part of supply chain to solve the account receivables financing. But it s do less to the front end financing, i.e. purchasing equipment and expanding capacity. This could be concluded from below two reasons: 1. Factoring is still in the preliminary stage in China, so there is little case study to fully perform the advantages of factoring. 2. Currently, the banks are the major financial institutions to do factoring. Front end financing in supply chain is risky, 6which requests the banks to improve the management and concept. Our banks have not qualified to do factoring at present stage. Along with the growing factoring market, the factoring function development, it s realistic for our banks to promote factoring to finance the front end in the supply chain, which could only helps SMEs financing, but also improves the efficiency of the supply chain. 4.2 process and advantage We will show the process of factoring in the front end of supply chain through the following table. Template two: Factoring in the front end of supply chain Factoring in the front Traditional Factoring end of supply chain Category the Financing Institution of Factoring Capital Flow Material Flow Dealer/ Raw Manufacturing Shopkee Material Factory per(over Supplier seas) As the table indicates, the processing procedures of the Factoring are as follows: (1)the manufacturing factory acquires the overseas order and signs the contract of processing-trade (2)the manufacturing factory asks the factors for the credit line of the importer which he makes business with (3)the domestic factors make the credit evaluation on the overseas importer through the international factors organization, and notify the manufacturing factory the authorized credit line (4)according to capital owned and the credit line authorized by the factors, the manufacturing factory signs the purchase agreement with the raw material (machinery) supplier (5)the manufacturing factory ask the factors for the purchase fund under the credit line (6)factors make payment to the raw material (machinery) supplier with the authorized fund and the capital owned by the manufacturing factory (7)the raw material (machinery) supplier deliver the goods to the manufacturing factory (8)the manufacturing factory organizes the production (9)the manufacturing factory finishes the production in time according to the agreement and delivers the goods to overseas 550

8 (10)the overseas distributor effects the payment for the goods to the factors, and the factors make the final settlement with the processing factory Seeing from the (Draft 2), the entry of the factors makes the capital chain independent which is weak before and make the factoring financing impenetrate the whole capital chain, so, the factoring fund, which depends on the repayment ability and favorable credit of the overseas supplier, can make the optimizing configuration on the capital-weak- tache of the supply chain. The front end of supply chain finance of the international factoring, can settle the processing factory s problem of production ability deficiency which is caused by the lack of the capital, and it is in favor of the re-production enlargement of the processing factory, the direct transaction of the buyer and seller, decreasing the trade procedures, improving the efficiency and flexibility of the supply chain, and the competitive power of the weak enterprises on the supply chain. In China, it is a financing-innovation-production which has good marketing potential, but it also inevitably has risk to some extent. 4.3 The risks and restrict conditions of supply chain advancing finance of the international factoring As a new financing-innovation-production, the front end of supply chain finance of the international factoring inevitably has some risk. The follows are the possible risk and relevant countermeasures: (I) Risks o the front end of supply chain finance of the international factoring 1 Risks from the supplier: default risk.the supply of the goods is not in time or do not meet the quality requirement, and thereby affect the production schedule 2 Risks from the processing factory: a. default risk Can not organize the production efficiently, cause the delay of the producing time-limit, or the final production do not meets the requirement of the importer; b. the credit risk Put the raw material or machinery into other uses, not accomplish the order according to the agreement 3 The risks from the importer: a. The credit risk that can not effect the goods payment in time; b. The risks caused by the trade dissension. (II) The countermeasures to the risks Aiming at the main risks above, the factors, as the kernel of the supply chain, should take the different measures to keep away and resolve the risks: 1 Choose the experienced overseas factors through the international factoring organization, to make investigation on the overseas importer, and select the large international enterprise which has large scale and good popularity as the importer. 2 Select the enterprise which have fine scale and ability, some capital owned, but can not make re-production enlargement and meet the larger order due to its limited scale, as the processing factory. 3 The selected processing factory, should have set up the relatively stable supply-demand relations with its upriver supplier and overseas purchasers, and the time of factoring made on it should be several and not once. That is to say, the factors should strive for the whole purchase for the series funds receivable; make the global factoring for the same kinds of orders in one year or a longer period. 4 Perfect the contract management. Nowadays the laws aiming at the factoring are not perfect in China, therefore, there should be flawless contract terms and conditions in the capital operation of the whole supply chain, in order to restrict the parties on the supply chain. 5 Tag The finance of the international factoring at the front end of the supply chain the thesis discusses is comparatively mature production overseas, but in our country, it is a financing innovation under the historic background of finance marketing opening. Presently, the factoring has taken on a flourishing developing tendency in the worldwide, but in our country its developing speed is still relatively laggard. Therefore, in order to make the international factoring service better for the domestic middle and small sized export-producing enterprises, the corporate efforts of the enterprises, factors and government are needed. Firstly, the domestic export-producing enterprises are small in scale, and the development of the international business are late. Facing to the international marketing competition, the consciousness of 551

9 anti-risk are weak, the marketing and price are controlled by their agents, most of the enterprises pay more attention to the contract, price and production, but ignore the foreign exchange capital risk management. Some high-class managers know only a little about the foreign exchange capital management of our country. The enterprises lack the professional support on how to use the banking foreign exchange financing productions, how to elude the exchange rate risk efficiently, how to retain and increase the value of the foreign exchange, and how to acquire the international trade finance. And on the other hand, that also suggest that enterprises are short of professional personnel, being not able to control the dealing cost, having to receive the loss caused by the exchange rate fluctuate passively. The financial personnel have no enough knowledge on the payment terms of the international trade and operation risks, have no enough knowledge on the banking foreign exchange financing productions, so they can not supply necessary information or the decision gist for the decision maker of the enterprises. Secondly, banks, the main factors presently, should perfect their financing services and make financing innovation positively. On the basis of realizing the marketing demands, combining the tenor and payment terms of the trade of their clients, they should promote the new productions constantly. Moreover, they should take the reference of the international banking, make amalgamation of the traditional and new trade financing measures, and commend the clients to use relevant products or make the most suitable financing productions and services for the clients. Thirdly, the government departments should provide the support in the aspects of information supply, service betterment, creating environment and so on. The relevant function departments of the government should supply services for technology development and research, personnel training, information consultations and so on, to improve the general qualifications of the middle and small scale enterprises. And they should also give some favorable policies on all the aspects, and set up a good flat roof for the development of the import and export business of the enterprises. Reference [1]Ye wei, Wang ying The Advantage Analysis Of the Enterprise Financing In Virtue Of Factoring The Enterprise Reform and Management 2nd Schedule, 2006 [2]Li xin feng, Zhu xiang yu, Zhu jian guo The International Factoring the Praxis Choose of China to Participate In the International Competition Commerce Modernization Jan [3]Xu yan The Development Research of the Factoring in Our Country Financing Research 2nd Schedule, 2003 [4]Yang hong, Xiang wei xing The Development Status and Countermeasure Research of the International Factoring Modern Economy Research 2nd Schedule, 2006 [5]Yang shao hui the Supply Chain Service Seeing from the Business Pattern of Commercial Bank 10th Schedule, 2005 [6]Xie feng jun, Jia wei qiang The Problem and Countermeasure of the Middle and Small Sized Enterprise International Trade Financing Commerce Modernization 4th Schedule,2006 [7] He wei The Supply Chain Financing See from the New Business Pattern of UPS Hong Kong Voyage Event Weekly 3rd Schedule,2005 [8]Zhang ying Secret of UPS Financing Solving Project Global Supply Chain 24th Schedule,2005 [9]Xiao zhao qing Factoring International China Commercial Publishing Company [10]Wei long, Bai xue China Export Commodity Structure Status and Adjust Strategy Wuhan Technology Institute Studying Newspaper 2nd Schedule, 2003 [11]Lawrence Ma Bigpotential,slow take-up Business Money International march/april 2006 issue 5 [12]John Harnmond. Supply chains and the facilitation of payments [C]. United Nations Economic Commission for Europe, 29th May [13]Alan N Bcattic. Maximizing the Financial Supply chain in Support of Trade Flows [R]. HSBC s Guide to Cash and Treasury Management in Asia Pacific,2005. [14]Leora Klapper. The Role of "Reverse Factoring" in Supplier Financing of Small and Medium Sized Enterprises[R]. World Bank,September,