Usually, Non-Banking Financial Companies (NBFCs) majorly oversee the funding requirements of the Micro, Small, and Medium Enterprises (MSMEs). Favourably, the Factoring Regulation (Amendment) Act, 2021 issued by the RBI in January seeks to broaden the participation of NBFCs in the factoring business, thus expanding the avenues of Working Capital credit to even small businesses. Hence, Factoring can be a better alternative to get funding for MSMEs now.
Before we delve into the benefits of Factoring for MSMEs, let’s understand what Factoring is. The term Factoring refers to a transaction where an entity (like an MSME) sells or mortgages its receivables to a third party – a ‘Factor’ (a financial intermediary like a bank or NBFC), to get immediate funds. The immediate positive fallout of Factoring is the access to ready capital to MSMEs which is in line with the discounting of bills.
Since the RBI has simplified the rules for NBFCs, they are now empowered to foray into the Factoring business. This welcome move is expected to boost the lending portfolio of NBFCs and will deliver quick loans to the MSMEs. Till now, many NBFCs have been operating on the age-old model of being Asset finance focused. I consider the Asset finance model to be detrimental to the growth of MSMEs and also their effective Working Capital utilization. The importance of understanding Working Capital Management and the need for additional Working Capital should be one of the priorities of MSMEs while running their business. With this regard, Factoring plays an important role in Working Capital Management.
The Working Capital requirements for MSMEs can be triggered due to various factors like the occurrence of seasonal differences in cash flow, improved business, and events of crisis management. Other factors may include paying wages to temporary employees or to defray costs of other project-related expenses. Such challenges faced by MSMEs can be addressed by levering Factoring services by NBFC-Factors.
The benefits of the Factoring Regulation (Amendment) Act, 2021
Since the announcement of the Factoring Regulation (Amendment) Act, 2021 many doors have opened for both NBFCs and MSMEs to grow exponentially. Firstly, the Act empowers the central bank to employ norms that support better oversight of the $6-billion Factoring market. The Act has many benefits viz. it has eliminated the need for a Factor to report every transaction and entrusted it to the TReDS exchanges to report on their behalf, which opens the field to NBFCs that do not operate as specialized Factors.
5 reasons that make Factoring the most effective low-cost Working Capital solution for MSMEs
1. There is no need for collateral security. This will eliminate the need for cumbersome documentation.
2. Factoring is not required to be shown as a loan on the Balance Sheet.
3. Increasing use of Technology will be employed. Customer experiences as a borrower for MSME will be enhanced and NBFCs will be able to retain their customers.
4. Smoother and quick availability of Working Capital will automatically result in a faster turnaround time.
5. Businesses will now only pay for what they utilize. Fixed Cash Credit based working capital will not be required.
Factoring Services Outlook- The Way Ahead
Once new Factors step in, Working Capital volumes could rise to the rescue of many MSMEs, and one can only look up from here on. The Government is determined to support the MSME Sector for its vast employment potential and quality of goods produced. An array of measures to grow the MSME Sector have already been announced which is a win-win situation for all stakeholders. It’s time to go the Factoring way and help your businesses grow faster.
Views expressed in this article are the personal opinion of Dr Ravi Modani as Founder and CEO at 121 Finance.