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Why SMES should use factoring as a financing vehicle

by , 02 March 2015
Access to finance is one of the major problems for small businesses in South Africa. Although plenty of channels to finance the growth and development of the SME sector are available, they are insufficient.

But there is an important option available to SMEs financing in South Africa, explains Bruce Dzenga, a Development Finance Expert. It's called reverse factoring.

Here's how it works.

Dzenga argues that the global pattern of factoring indicates that it may have an advantage compared to other types of lending, "such as loans collateralised by fixed assets, under certain conditions" and this is why it proves to be a strong tool for financing.

For systems with weak commercial laws and enforcement and inefficient bankruptcy systems? Factoring is an efficient solution.

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As Dzenga states, factoring provides small and medium enterprises (SMEs) with working capital financing.

What's the core idea?

Unlike traditional forms of working capital financing, factoring involves "the outright purchase of the accounts receivable by the factor, rather than the collateralisation of a loan".

This also means that the virtue of factoring in a weak business environment is that "the factored receivables are removed from the bankruptcy estate of the borrower and become the property of the factor".

What are the advantages for your company?

This particular financial service includes credit protection, accounts receivable bookkeeping, collection services and financing.

Factoring is a type of supplier financing in which firms sell their credit-worthy accounts receivable at a discount (equal to interest plus service fees) and receive immediate cash.

Don't see factoring as a loan, the same source adds, because you don't have any debt repayment and no additional liabilities on the firm's balance sheet.

Moreover, Dzenga draws attention to the fact that factoring has been recognised by development finance institutions such as the International Monetary Fund (IMF) and the African Development Bank (ADB) as an important source of financing SMEs in both developed and emerging markets.

It is a perfect fit for an economy like South Africa where one-third of the country's GDP originates from small and medium enterprises and the sector employs approximately 20 percent of the South Africa's work force, according to World Bank report in 2010, cited by Dzenga.

We hope this information on factoring has been useful to you!

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