Boosting Rwandan Companies’ Growth with Factoring [2017 post]

Lack of access to finance, particularly working capital, is an impediment to SME growth in Africa and in Rwanda

Small and medium-sized enterprises (SMEs) are key drivers of economic growth and employment everywhere in the world. SMEs need to have access to finance to efficiently manage and grow their business. For example, they usually require credit to bridge the gap between the time at which they would like to be paid as a supplier (on dispatch, at latest), and the time at which their customers will want to pay (on delivery, at earliest, but more commonly after a payment period of 30 to 90 days).[1] What’s worse, companies often have to incur costs of production long before they have even finished their products or service provision.

Working capital, a form of short-term finance that enables enterprises meet their short-term financing obligations, is important for SME profitability. Having access to and efficiently managing working capital can single-handedly determine the success of an enterprise. Globally and in Africa, researchers have established a relationship between the accounts collection period and profitability in a number of studies.[2] As part of developing a successful business, entrepreneurs must design an optimal working capital level for their company to avoid missing business opportunities that arise quickly and/or negative effects on their profitability.

Because of its importance, an absence of or weak access to finance can strongly inhibit SME development in any market. SMEs suffer more than larger enterprises from market weaknesses that result in credit rationing, higher costs of “screening” and higher interest rates from banks.[3]

SMEs in developing countries are even more vulnerable than SMEs in developed countries. Estimates have shown that between 14 and 20 million SMEs are either unserved or underserved in developing countries, amounting to a credit gap of nearly US$1trn. [4] The World Economic Forum has ranked the lack of access to trade finance as the most problematic factor for exporting in Sub-Saharan Africa.[5]

In many developing and emerging market economies, banks are hesitant to extend credit to SMEs for a number of reasons, including a lack of a record of accomplishment, a lack of collateral against which to raise debt finance, and a lack of consistent reliable risk-assessment processes. Banks face difficulties in managing SME risk and experience high transaction costs servicing SMEs. Even smaller financial institutions are not necessarily better positioned and equipped to meet SMEs financing needs.[6] Moreover, since the financial crisis of 2008, a number of global banks have “retrenched” to what are considered “safer” markets.[7] From the borrower’s perspective, the extensive paperwork requirements by banks resulting in long lead times, high-interest rates and products not tailored for their needs prevent SMEs from seeking bank finance.

All these challenges are even more pronounced in Rwanda, where 98% of all firms are non-large[8], with 70% being financially un- or under-served[9]. According to Rwanda’s Integrated Business and Enterprise Survey (IBES), cash flow problems is the leading cause of bankruptcy in Rwanda. Research carried out by BeneFactors in 2017 indicates that many SMEs find themselves turning down market opportunities due to lack of working capital to service multiple clients at the same time. This underutilisation of existing capacity, with average capacity utilization in companies at less than 65%, leads to high operational costs, making Rwandan companies less competitive than their peers in other regional markets.[10]

Factoring offers access to working capital in a way that avoids many of the constraints faced by SMEs

In the context described above, supply chain finance arrangements such as factoring enable African SMEs to gain access to finance they are not able to have through traditional means. Factoring refers to a method used to provide working capital to SMEs without collateral. In a factoring relationship, the account receivable (invoice to be recovered from a buyer) of a company is sold to a financial institution (factor) at a discount. The factor then provides working capital to the SME (with potentially other services such as managing receivables) and later collects the credit amount owed from the buyer.[11]

Factoring leverages the creditworthiness of a company’s customers to enhance borrowing potential and provide access to working capital. The attractiveness of factoring is increased by the fact that it is a simple asset sale, and contrary to a loan, it does not create a liability for the company in question.[12] This means that financing can be extended quickly, flexibly and reliably without the need for collateral. All these elements make factoring a much more attractive source of capital for SMEs than a traditional banking loan.

The global factoring industry volume in 2012 was 2.1 trillion euros, equivalent to 4.2% of global GDP, of which Africa’s share was only 24 billion euros (1%), with South Africa alone contributing 21 billion euros (91%). Although Africa is still an insignificant player in the global factoring market, factoring volume have grown rapidly over the past 10 years, from 5.9 billion euros in 2001 to 23.9 billion in 2012. Africa’s average annual factoring growth over the past 10 years has been 14.2%, which exceeds the global industry average of 8.6%.[13] Key markets for factoring in Sub-Saharan Africa today are South Africa, Nigeria and Kenya.

 While the headline cost of factoring financing may appear high, in practice the benefits clearly outweigh the costs, both for the company and the economy as a whole. Research indicates that the availability of factoring internationally has a positive impact on global trade trends –a 10% increase in global factoring may be responsible for 0.5% to 1% in increased trade. This causal relationship has been robustly established by WTO research.[14]

There are ways to improve the availability of factoring and thus boost Rwandan companies’ growth prospects

Despite its benefits and recent growth in some markets, factoring has not yet taken root in sub-Saharan Africa, including Rwanda. A number of obstacles, including legal, regulatory, informational, and cost barriers impede factoring growth in various African countries. A comprehensive facilitative legal and regulatory infrastructure to govern factoring activity is needed. [15]

Governments have a key role to play in building a conducive business environment for the factoring industry and private business in general. The Rwandan government should adopt a clear and dedicated factoring law that enables assignment of receivables, which is essential to ensure factors can become the uncontestable owners of the receivables (an intangible asset), against which they are advancing funds. Regulating factoring by contract or banking law alone is not sufficient, as it exposes factors to risk and uncertainty. The law should also make it clear that independent factors are not be treated as banks or financial institutions, to avoid applying rigorous banking requirements on nonbank factors. Rwandan legislators can make quick progress in putting in place a factoring law by adopting either an IFG model factoring law – a global factoring legislation harmonization initiative – or the model factoring law drafted by Afreximbank in coordination with other stakeholders including central banks, the Association of African Central Banks (AACB), and the OHADA Secretariat.[16] At the same time, the local assignment law should be clarified to minimize the risk of suppliers selling the receivables to multiple parties.

There are also a number of government policies in Rwanda that should be revised to make factoring a more accessible source of working capital. The public procurement law’s requirement that government payments can only be paid into the supplier’s account should be eased to allow government receivables to be paid directly to a factor. Public credit guarantees such as those provided by BDF or BRD’s EGF window should be allowed to be used for factoring services. A central depository for factored invoices is also needed to create the transparency and trust needed for factors to be confident that the invoices they are buying have not been factored to someone else already. The South African e-factor platform and the Mexican NAFIN Platform are examples of such platforms that have created transparent market places for factoring, bringing together SMEs and financial institutions.

The government, PSF and its affiliate associations, factoring companies and business schools should bridge the gap in factoring understanding, knowledge and skills by engaging in active capacity building and training programs in factoring, and preparing and participating in marketing events that promote factoring as a source of finance. SMEs in Rwanda are currently unlikely to be aware of factoring as a financing option. Increasing awareness of it is likely to lead to significant growth and business development opportunities in a large number of companies, greatly supporting Rwanda’s national economic development objectives.

Bibliography/further reading

Auboin, 2015. Improving the availability of trade finance in developing countries: An assessment of remaining gaps. WTO Staff Working Paper ERSD-2015-06. https://www.wto.org/english/res_e/reser_e/ersd201506_e.pdf

Auboin et al., 2016. Supply Chain Finance and SMEs: Evidence from International Factoring Data. WTO Working Paper ERSD-2016-04. https://www.researchgate.net/profile/Robert_Teh/publication/306032019_Supply_Chain_Finance_and_SMEs_Evidence_from_International_Factoring_Data/links/57ab5da108ae42ba52aed993/Supply-Chain-Finance-and-SMEs-Evidence-from-International-Factoring-Data.pdf

Awani, 2016. Strategies for Factoring Growth in Africa. FCI World Factoring Yearbook 2016.

Nakusera et al., 2008. Enhancing the role of factoring and leasing companies in providing working capital to Small and Medium Enterprises (SMEs) in Namibia. Bank of Namibia Occasional Paper 3-2008. https://www.researchgate.net/publication/236175157

Saleem et al., 2015. Raise the anchor. IFC Feature 4 March 2015. https://www.ifc.org/wps/wcm/connect/0128890049390f968a6efacda2aea2d1/IFC_SCF_Feature_Article_Raise+the+Anchor_TFR+Mar15_00000003.pdf

Tomusange, 2015. Factoring as a Financing Alternative for African Small and Medium-Sized Enterprises. Walden University dissertations. http://scholarworks.waldenu.edu/dissertations/1578

[1] Auboin, 2015.

[2] For an overview of some of these studies, see Tomusange, 2015, p. 22.

[3] Auboin et al., 2016.

[4] Saleem et al., 2015.

[5] Auboin, 2015.

[6] Tomusange, 2015.

[7] Auboin et al., 2016.

[8] Rwanda Establishment Census, 2014.

[9] Saleem et al., 2015.

[10] IBES, 2015.

[11] Nakusera, 2015.

[12] Auboin et al., 2016.

[13] Tomusange, 2015.

[14] Auboin et al., 2016.

[15] Tomusange, 2015.

[16] Awani, 2016.