This article expands on the topics we covered in the previous video.
In the video, factoring (a.k.a. invoice financing) is recommended as a good financing option for SMEs who do not have much in the way of assets.
In Singapore, large and affordable loans are only available to companies that have large assets (usually property) to pledge as collateral for the loan.
SMEs are mostly limited to large and expensive loans (for example, term loans of up to S$500k with an interest rate of 10-12%) or a small, government-backed loan (usually up to S$300k with an interest rate of 6-8%).
By using factoring facilities, business owners can essentially unlock unlimited revolving working capital with an effective interest rate of about 7-10%. This can happen as long as the business is generating receivables while the factoring facility line granted can easily exceed S$500k.
Finally, because factoring is the simple encashing of tied-up assets without adding debt, it may be a better financing option compared to other choices such as a term loan.
This is because of the nature of factoring as compared to loans.
For SME owners who intend to grow their business, factoring should be the first choice of financing. As factoring is essentially early payment for goods/services delivered, it helps reduce an SME’s cash turnover cycle (i.e. they receive their upfront profits faster) and allows them to take on new jobs. This allows them to scale much faster.
However, factoring works only if the business is already generating receivables.
On the other hand, a term loan (the borrowing of a lump sum with a fixed monthly repayment schedule) is usually more suitable for a one-time investment. The downpayment for a new store or purchasing new equipment will usually require a term loan as most SMEs can’t afford to use its cash reserves (typically their source of working capital) for these purchases.
Protection against non-paying clients is one benefit of invoice factoring. Such a factoring arrangement is known as Non-Recourse Factoring. Simply put, an SME is not obliged to repay the factor (financing company) if its customer is unable to pay due to bankruptcy/default, at the cost of a higher factoring fee.
The more sales a business makes, the more it can expect to receive in encashed invoices. In that sense, factoring can provide a source of unlimited working capital. This may be preferable to an overdraft facility for example, as a growing amount of expenses is covered by a growing amount of receivables.
Factoring companies also take on payment collection on behalf of clients, saving you time and resources. It may prove especially helpful when dealing with perpetually late-paying clients. The factoring companies have established efficient ways for collection.
Finally, factoring can be extremely important for small exporters in Singapore. Most established overseas exporters trade on open account terms, which means they export goods before payment is due. Such terms involve risks, which may not be acceptable to SMEs in the trade. Export factoring can help SMEs to trade on the same terms as the big players.
Once the goods are exported, the factor (financing company) will pay the exporter after verifying, while waiting for payment to be made. The factor essentially takes over the collection of payment from the foreign importer as well as the risk of non-payment.
Watch part 1 here!: Clearing misconceptions about invoice financing!
Edited by: Paul Hong
Lendingpot.sg operates a Business Loan Marketplace that allows an SME to connect to multiple lenders with just one application, allowing the SME to know who its prospective lenders are and the rates that they offer, in a very short time.
Eric Koh is passionate about helping SMEs grow and has spent years interacting with business owners at OCBC and IFS Capital. He is interested in 70s rock ‘n roll, the odd novel and copious amounts of historical trivia.