CERTIFICATE COURSE ON MSME | TRADE RECEIVABLES FINANCING
This article covers the concept of Factoring as per the prescribed syllabus of IIBF MSME 2024. Here, you will get to read the meaning of factoring, how it works and what are the benefits of availing the services of factors to MSMEs from the Study material of MSME for 2024.
MSMEs Current Situation
Micro, small and medium enterprises have always been subjected to inconvenient trade practices and have to face difficulties when it comes to conversion of the trade receivables into liquid funds.
To help them in converting their money blocked in trade receivables into liquid money, RBI had set up the system of TReDS. TReDS is an effective institutional mechanism all over India that finances the trade receivables of MSMEs with the help of multiple financiers.
After the implementation of TReDS, MSME suppliers have started to enjoy a lot of benefits. The most notable benefit that has come up is easy and quick invoice and bill discounting and that too at competitive rates.
This financing is done without recourse to the suppliers from the MSME sector. TReDS is an electronic payment system that has eliminated cash application, discrepancies, and collection costs.
HOW THE FACTORING WORKS
Factoring has allowed the businesses to obtain funds based on the future incomes which are supposed to be received from an account receivable or a business invoice.
These account receivables or invoices represent money that is owed to the company for the sales that have been made on credit.
For the purpose of accounting, receivables are recorded as current assets in the balance sheet because money is collected or received from the customers in less than a year.
There are times when companies experience a shortage of cash flows because they are short-term debts or bills are greater than the income which is generated from the sales.
When a company’s sale is done via accounts or bills receivable, there are chances that this might not be collected in time for the company to meet the short-term liabilities of the company.
This is when the companies cancel their account receivables to a financial provider, called a factor, in exchange for cash.
BENEFIT FOR SUPPLIERS
Quick & easy finance of account receivables at reasonable rates
TReDS provides an easy and quick way through which one can finance their receivables at convenient or reasonable rates. When it comes to MSMEs, it also ensures that the funds are realized faster.
Better relationship between suppliers and buyers
Better Working Capital Management is enjoyed by the suppliers when they have the option to expand their business faster by discounting their bills receivables. This continuous process of discounting has led to better handling of the receivable cycle which has resulted in a better relationship between the buyer and suppliers.
Financing without recourse for supplier
TReDS another benefit is that the supplier is financed without recourse, which in other words means that the supplier gets the funds from the financier and the financer cannot recover the funds from the supplier if the account receivable doesn’t pay.
Financing without Collateral
Financing done through TReDS doesn’t require any collateral which is often the case with other credit facilities from the banks or Financial Institutions. In a typical case of hypothecation on a mortgage of assets, collaterals are needed to be provided.
Because of TReDS, financing through TReDS has become paperless and hassle-free.
IMPROVED CASH FLOW LEADS TO MORE OPPORTUNITIES
Even though factoring is relatively more expensive than any other form of Financing, it still helps the company improve its cash flow. When the companies have immediate cash at their end, new business opportunities can be taken up.
FACTORING REGULATION BILL TO STRENGTHEN MSMES
Factoring Regulation (Amendment) Bill, 2021, has been approved in the Lok Sabha which was first introduced on 14th September 2020. There are different amendments that have been proposed to the bill to boost the cash flows to MSMEs.
The main aim of the factory angulation bill is to liberalize the factoring Regulation Act 2011. This liberalizing is supposed to happen because of expansion in the scope of entities that can be allowed in the business of factoring. This broadening in the scope of entities is supposed to provide more chances for MSMEs and small businesses to access their working capital immediately instead of getting blocked in receivables.
As mentioned above, factoring is a business where MSMEs can sell their receivables and get immediate funds.
This amendment in the factory regulation bill proposes to allow all the non-banking financial companies to engage in the business of factoring instead of just a few.
Earlier, only the NBFCs which had been authorized by the Reserve Bank of India allowed in the business of factoring, and that too only if their principal business was in factoring & the majority of their income and assets were earned from the business of factoring.
This amendment will remove the participation of Limited Non-Banking Financial Companies and thereby provide an opportunity to non-bankers to carry out this business. This is going to result in the availability of more avenues for MSMEs to get their working capital through factoring. This is going to be especially useful for small businesses because they will have to stress less about their finances.
It is also expected that the amendment will help in increasing the supply of funds that are available for the small businesses if all the NBFCs are allowed to do the factoring business. This allowance will lower the cost of funds and enable excess to the credit more easily.
The thing to be noted is that this amendment is also trying to bring some of the terms in sync with the international definitions. This amendment will be in the definitions of assignment, receivables, factoring business, and by inserting a new definition ‘Trade Receivables Discounting System’.
This way, banks, and non-banking financial companies will acquire the syllables of a company at a discount and realize them from the entities from which it is owed, thereby, helping the companies to monetize their bills receivable and providing solutions to cash flow problems.
The Factoring Regulation (Amendment) Bill will help the micro, small and medium enterprises as well as small businesses by providing them more opportunities for liquidity in this pandemic situation.