Working Capital Finance for Small to Medium Size Businesses
The only reason that factoring in South Africa represents approximately less than 1% of the total working capital loans/finance afforded to small to medium size businesses compared to, for example, in the UK where it represents approximately 6% to 7% of such working capital finance, is because in South Africa it remains a relatively unknown form of finance.
Financiers need to create an infrastructure in the South African environment encouraging interaction between small businesses and, as the fundamentals of our economy continue to change with increasing smaller businesses becoming more and more dominant, factoring now becomes the only suitable form to finance the growth of these small to medium size businesses.
High Street banks look for unrealistically conservative gearing ratios and are not suited to finance smaller businesses, those doing from as little as R500 000 per month to as high as R5 000 000 per month in turnover.
With the big corporates striving to source the correct BEE procurement and with Government’s drive to promote both black economic empowerment and the Buy South African campaign, which will affect most large businesses in South Africa in terms of their continued need to improve their BEE scorecard, and whilst most of these corporates would be happy to support black entrepreneurs and previously disadvantaged entrepreneurs, the lack of experience and capital of many of these entrepreneurs makes this extremely difficult.
Factoring can provide the answer since in addition to providing working capital, i.e. by providing bridging finance for the BEE supplier to the corporates and allowing them to extend the credit terms required to suit the corporates’ administration structures, the factoring industry also performs a professional debtor administration service for these clients, which can be viewed as a form of outsourcing of the debtors function.
One area where Government could come to the assistance of these small to medium size BEE entrepreneurs is to re-look at the Government’s tenders/contracts awarded by Government and quasi-Government departments to the SME’s where invariably one of the conditions is that the SME’s may not cede their rights to any third party. Whilst we fully understand the rationale for this condition, this prohibition inhibits the ability of the SME’s to raise funds by ceding the right to payment to the Factor. By Government, and for that matter the larger corporations, allowing the cession of the right to payment under the contracts they award to the SME’s, they will enable the SME’s to raise funds and continue trading rather than be hamstrung waiting for payment and possibly face going out of business because of the delayed payment structure of the big corporations and Government and quasi-Government departments.
The factoring industry continues in its attempts to explain the benefits of factoring to the potential users so that the assistance afforded to hundreds of small to medium size businesses in the past can now be extended to similar size businesses that are beginning to carve a niche in the market.
Factoring can be seen as the missing link in the form of bridging the lead time between the SME’s having to pay their supplier and receiving the money owed to them by their customers at a later date. By factoring their debtors the SME’s are able to obtain the necessary funding upfront (normally up to 75% of the value of the invoice raised and the balance on receipt by the Factor of the money owing by the customer). This very necessary cash flow bridging benefits the SME’s by strengthening their cash flow position, alleviating the necessity of having to give away settlement discounts to entice early payment, and meeting supplier payments timeously thereby securing purchasing discounts.
In the true sense, factoring does not represent borrowing on the part of the company but rather the acceleration of the receipts owing by such company’s own debtors.
It is for this reason that a factoring company normally places more emphasis on the creditworthiness of its client’s customers rather than the strength of the client’s balance sheet, especially through outsourcing of the debtors administration function to the factoring house which enables the factoring house to better control its security.
Cash flow, the ‘energy’ moving in and out of a client’s business, is the most critical item on any business priority list. Without cash the business cannot pay its bills, expand, or even remain in operation, and giving customers interest free loans is not helping the client’s business either.
The majority of companies which adopt an outsourcing strategy say that it allows them to concentrate more on their core business, experience cost reductions and increase profitability and efficiency. This is also true of the Factors’ clients who normally experience a complete turn-around by outsourcing their debtors administration, enabling them to concentrate on their core business and competence and at the same time to secure the working capital finance they need in a facility that grows in line with their increased levels of trading.
