Factoring is a clever alternative to bank loans that combines working capital financing, credit protection and outsourced collection services. And it could soon be available to businesses in Cambodia.

Cambodian exporters often find themselves in a difficult situation: an international buyer has placed a large order for their product but it could be weeks or months until they receive payment, if at all. In the meantime, the exporter needs cash to pay fixed operating costs such as keeping the factory running and remunerating staff.

Late and unpaid invoices can be a real drag on a company’s cash flow. Fortunately, international trade finance has evolved and offers a solution that accelerates cash flow by unlocking the value of a company’s accounts receivables.

Factoring is the process by which a business sells its accounts receivable to a third-party financial institution known as a factor in exchange for immediate cash.

The factor typically provides about 80 to 90 percent of the value of these unpaid invoices upfront, often within days. It then pays the balance of the invoice – minus fees – to the company once it collects payment from the customer.

The arrangement is often made without recourse, which means the factor assumes all risk on collecting payment from the foreign buyer, and must absorb the loss if the buyer fails to pay.

Factoring has been around for centuries, but its use in international trade has surged in recent decades as cross-border trade has increasingly been conducted on open account terms – where goods are shipped and delivered before payment is due, which is usually another 30 to 90 days.

“Importers overseas are asking for open account terms,” said Lee Kheng Leong, Asia Chapter director of FCI, an umbrella organisation for private factoring companies worldwide. “However, exporters are not prepared to sell on open accounts because of the risks.”

He explained that while open account transactions are advantageous for the buyer, they carry a lot of negatives for the seller. Among these is the possibility that overseas buyers will delay payment on the consignment or be unable to pay due to financial difficulties. Moreover, granting credit to buyers for up to 90 days ties up working capital resources. It can also be a challenge to collect payments from another country, often in a foreign language.

Factors make their profits on the invoice discount – the difference between the face value of the invoice and the amount they pay to the exporter. The discount includes interest on the advance and other costs connected with the management and collection of the assigned accounts receivable – which according to Leong, works out to about the same cost as a bank business loan or line of credit.

“The financing cost of factoring is similar to bank borrowing,” he said. “However, there is a service fee of 0.75 percent to 1 percent of the invoice value, which is for the credit protection and collection service.”

According to FCI estimates, total factoring volume worldwide exceeded $2.5 trillion in 2016. That equates to about 15 percent of global trade.

Despite this, the concept of factoring is relatively new in Cambodia and few companies have even heard of it. But efforts are under way to introduce the trade-based finance tool, which could be available by the end of the year.

In February, FCI and the International Finance Corporation (IFC) jointly organised a conference in Phnom Penh to share international expertise on factoring and help local lending institutions and relevant industry players build networks. A two-day workshop that preceded the event provided training on the operational and technical aspects of factoring for frontline and mid-level staff.

According to Peter Mulroy, secretary general of FCI, Canadia Bank is currently the umbrella organisation’s only member here, having joined last year. However, Acleda Bank has expressed interest in joining, as well as ABA Bank, a local subsidiary of the National Bank of Canada – a longstanding provider of factoring services.

Ung Sam Ol, head of Acleda Bank’s trade finance division, said his bank is looking to offer both domestic and international factoring services to local businesses. He said Cambodian companies, particularly producers of garments and agricultural goods, stand to benefit.

“Factoring can result in savings to management as well as providing an extra source of finance,” he said. “It is particularly well suited to exporters on open accounts, or those who want to expand their volume of trade by selling more on open accounts.”

Sam Ol noted that exporters can significantly reduce their overhead costs and management time by relying on the factor’s overseas network and credit reference system, leaving the factor to collect invoices and chase down delinquent payments.

“Debtors tend to settle more quickly because the factor is more efficient at collecting the debt,” he added.