Trade finance assists both importers and exporters in developing trust in their dealings with one another, thereby facilitating trade.
The Micro, Small, and Medium Enterprises (MSMEs) sector contribute significantly to the country’s socioeconomic development. In India, the sector has grown in importance due to its contribution to the country’s Gross Domestic Product (GDP) and exports. The sector has also made significant contributions to the development of entrepreneurship in India, particularly in semi-urban and rural areas. There are about 50 lakh registered MSME in India, they account for 45% of total exports & contribute very significantly to the GDP. In the past three years of digitalisation, many unorganised sectors may have shut down but at the same time new companies have set up in the ecosystem. In this digital era due to the evolution of fintech, MSMEs are supplying their goods to corporations that are availing finance in 24 -72 hours by supplying their invoice through mobile phones.
Trade receivable is the borrowing of funds against your outstanding receivables. A financer provides you with a loan or line of credit in exchange for a portion of your unpaid invoices potentially as much as 90%. Once the goods or services are delivered the seller needs to upload the invoice in the exchange and the listed financier disburses the payment once the corporate buyer acknowledges the invoice. In the process, uploaded invoice/s are traded online among bankers resulting MSME to receive the payment with lowest rate of interest as low as 4%. After the corporate buyer makes their payment to the seller, they inform the bank and bankers deduct the interest and repay the balance amount to the SME. In case of TReDs, SME receive lowest interest rate in case their buyers are having good ratings hence better rating buyers/corporate will give lowest interest to the seller. Trade finance assists both importers and exporters in developing trust in their dealings with one another, thereby facilitating trade.
Merits of using trade receivable:
- Trade financing is ideal for B2B companies experiencing cash flow issues as a result of unpaid invoices. You can use this type of funding to get capital quickly before your customers pay their bills.
- Trade finance has become an important method to boost revenue and efficiency of the companies in need for capital.
- Financing is done at a very low cost of interest as low as 4% due to bidding among bankers as compared to factoring or MSME loans between 10% to 20%.
- Trade financing allows a sense of security amongst the sellers that ensures them that the cash flow process would take place in time.
- Funding against invoice can be received between 24 to 48 hours.
Selling of outstanding invoices to a factoring company at a discount when you use invoice factoring, also known as trade receivable factoring. The company will pay you a percentage of the invoice amount up front before taking over responsibility for collecting the full amount. When the company receives the full repayment from your corporate client, they will send you the difference less the agreed-upon fees. Unlike a trade financing arrangement, invoice factoring requires your clients to pay the factoring company directly rather than you.
Merits of using factoring:
- Invoice can get factored based on your relationship with the factoring company.
- It may limit the scope for other borrowing because book debts will no longer be available as security
- Cash is available for capital investment and funding of your next orders as soon as orders are invoiced.
Demerits of factoring:
- High amount of interest rate may get deducted if customers delay payments as a bidding system does not exist and disbursement is done by the factoring company only.
- Factors will limit funding against poor debtor quality or poor debtor spread, so you must manage these funding fluctuations.
Under which circumstances MSMEs can’t access both.
In India the government has reduced the cap from Rs 500 crore to Rs 250 crore for an MSME to register on TReDs as a corporate buyer. MSMEs valued more than Rs 250 crore can now approve the invoice for their sellers based on their goods or service received from them, but the sellers below the turnover of Rs 250 crore will not get the benefit of registering as a buyer on the TReDs platform. Hence MSME selling goods and services to corporate buyer whose turnover is minimum Rs 250 crore can get the facility, however, MSME supplying goods and services to below Rs 250 crore category have to wait until they are eligible to present a good credit history to get the facility, in case of factoring any MSME delivering goods and services to another MSME who doesn’t have any credit history are excluded from such facility.
The writer is CEO at M1xchange TReDs.