What is Factoring?
Also known as accounts receivable financing, Obelisk’s affiliates specialise in accounts receivable financing, a traditional form of business lending that has been around for centuries. Factoring’s appeal has become particularly apparent at a time when banks are failing to fulfil their traditional roles as lenders. Invoices and post-dated cheques are purchased by third parties from companies that would rather not wait the standard 30 to 90 days for their customers to settle accounts. These are bought at a discount, immediately releasing cash for the company, and the third-party makes the profit when payments are fulfilled.
Factoring is an important alternative to the banking sector for the financing of small and medium sized enterprises. Given the high barriers to entry into the formal banking system in some markets, factoring companies have found an important market niche. Factoring is a highly regulated industry. In addition, cash advanced can be secured against assets which represent a comparatively low-risk form of lending when managed well.
Known in Brazil as “Fomento Mercantil”, factoring is a popular way for businesses to raise capital for growth. Obelisk’s competitive advantage is derived from the relationships established with the businesses we supported. The focus is on SMEs – the engine of growth for most economies and the firms that benefit most from short-term capital. Obelisk works in tandem with the irrevocable purchase of credit rights, in the form of receivables which arise from the sale of goods or services that have maturities ranging from 30 to 90 days. The factoring company assumes the credit risk associated with the negotiable instruments, which has remained historically low for the past 10 years in Brazil due to the severe penalties existing for defaulted credits.
1. High Regulation
With a highly regulated financial market, Brazil has one of the most advanced banking systems in the world. The strict lending laws and penalties give receivable financing firms an advantage compared to other types of lending, such as collateral loans by fixed assets. Factoring companies function within a framework that is dictated and strictly monitored by the Central Bank of Brazil, COAF (Council for Financial Activities Control) and ANFAC (National Association of Societies of Receivable Financing). A strong legal structure and safeguards are implemented and strictly enforced to ensure that companies have its receivables and operations executed in a proper manner. Receivable financing must be based on commercial sales and is governed by Brazil’s Civil Code. It can be conducted only with ‘legal persons’ or enterprises and not with individuals.
2. High volume, Low default
The most common accounts receivable are ‘duplicatas’ (commercial invoices), which account for almost 60% of all factoring receivables. Others are cheques, bills of exchange, bills of lading, warrants, promissory notes and post-dated cheques. The latter can be issued to cover mercantile sales which started from the country’s high inflationary years in the 1980s when consumer credit was virtually non-existent, and consumers used post-dated checks to purchase goods and have evolved to the extent that they became the norm. These factors go a long way to explaining why Brazil‘s total national default rate on cheques is only around 2.8%, which is relatively low for the USD56 billion factoring industry.
3. Vital Liquidity
Factoring is a sizeable industry in Brazil and an important affordable source of finance for many firms. With its importance growing further in light of the global credit crisis, factoring has become a vital component of the Brazilian economy. There are just under 700 regulated factoring companies in Brazil, which provide services to more than 65,000 small and medium sized enterprises. 80% of these enterprises belong to the industrial sector, with creditor rights arising from mercantile sales amounting to a monthly turnover of around USD10 billion, or around 6% of all domestic sources of financing. ANFAC currently serves more than 120,000 businesses.
Factoring enables quick and, by Brazilian standards, relatively inexpensive access to financing. Whereas an annual interest rate of 47% for any loan product is considered unacceptably high in many developed Western economies, in Brazil it is regarded as the cheapest form of financing available to the average borrower.
Brazil and Credit Card Receivable Financing
Interest rates for credit cards are extremely high, with the annual interest rate of around 300% in May 2019. Being almost 18 times the average credit card rate in developed countries.
In Brazil, when a bank issued credit card is used for a purchase, the merchant is required to wait 28 days until the payment is remitted by the respective bank. Merchants can sell their credit card receivables at a discount to avoid the waiting period and release liquidity for continuing operations and facilitating growth. This method of financing is known as credit card factoring.
The receivables are purchased and the payment is received in full from the bank after the waiting period. With banks acting as the counterparty in these factoring transactions, defaults are lower than traditional forms of factoring, therefore reducing credit risk.