Dr. Ravi Modani is the founder of 121 Finance, one of a kind NBFC-Factors which provides Factoring and Working Capital Finance to MSMEs. A serial entrepreneur with an experience of 30+ years in which he has managed businesses in 5 countries remotely and has established a customer network across 32 countries. Dr. Modani has used his Doctorate in Working Capital Management to work towards streamlining the unorganised Working Capital space. Dr. Modani is currently working on the huge opportunity that lies with effective and efficient Working Capital Management to grow B2B trading. His goal is to enable every buyer and seller in India to get their smallest invoices discounted 24×7 with zero human intervention using AI and ML.
Medium, small, and micro enterprises (MSMEs) have issues while growing their businesses because they find it difficult to access Working Capital. To empower MSMEs to claim their rightful place in India’s growth story, it is imperative that mechanisms for supporting them be put in place. The Factoring Regulation Amendment Bill, 2021, is the answer to address these Working Capital worries of MSMEs. The Act now allows MSMEs to leverage the Factoring services provided by NBFCs who are registered as a Factor.
How factoring reinforces the MSME business model
The main difficulty faced by small businesses is a lack of Working Capital; they find themselves unable to procure the materials required to maintain their production and delivery schedules due to the long credit period. In the Factoring process, a seller who accepts an order raises an invoice and sends it to the buyer, through the Factor. The buyer accepts it and sends it to the Factor. The Factor provides the seller with up to 80% of the capital required, in return for a small fee or commission. The seller is now able to make further payments and keep their business cycle running without having to wait 30-90 days for the credit period cycle for their liquidity. Upon the final payment made by the buyer, the Factor issues the remaining payment to the seller. In this way, there is a constant inflow of Working Capital to the seller and no business needs to be halted because of a lack of funds.
The process is quick, streamlined, and low cost. The payment against each invoice is almost instantaneous via online platforms and the service charges levied by the Factor are minimal. This enables the seller to increase the number of operating cycles, and consequently, enhances profits. Factoring can enable sellers to reduce their inventory and increase their turnover. Hence Factoring plays a great role in reinforcing the MSME business model- especially by focusing on Working Capital problems.
How to improve Working Capital through Factoring
Optimal inventory management is one way to strengthen the Working Capital of a business. We have seen how MSMEs can use Factoring to control their inventory. Another way to strengthen Working Capital is to manage expenses better. Factoring takes care of this by providing immediate funds to meet all expenses. The net Working Capital ratio is a very important tool that is used to ensure the availability of short-term funds for a business to continue its operations. It is defined as ‘(current assets – current liabilities) / total assets. The higher the NWC ratio, the better the strength of the business to pay its obligations. Factoring helps a company maintain its current assets and hence manage its Working Capital.
Selection of key performance indicators for growth
Even for MSMEs, the Working Capital requirement can vary greatly depending on several factors. Critical among these is the operating cycle, the net Working Capital ratio, and the type of business. An MSME must carefully choose key performance indicators (KPIs) to monitor its performance and assess whether it is on track. The right KPIs can help a business set performance target and course-correct at the right time to achieve its business goals. Working Capital is an important KPI; other KPIs will depend on the nature of the business, its mission statement, and the financial model it chooses. They may include the cash flow, quantum of sales, amounts receivable, and profit margin.
Selection of a good Factoring company
Businesses need to be educated about the Factoring model and the processes it involves. The creditworthiness of the buyer is very important, and this must be ascertained by the Factoring company. Often a small business may be tempted to choose a Factor that has a lower cost load, but other attributes are equally important. The seller should ensure that the Factor has strong underwriting skills and comes with a good track record. The ability of the Factor to manage the back-office processing can be a great help and may offset its higher cost. Digitalization has come as a blessing for the Factoring business. It speeds up the documentation, decision-making, and transaction processes. Digitalization reduces the margin for error. All processes and transactions are approved on the Factor’s digital portal and the entire system is transparent and quick. Information regarding the movement of funds can be obtained in real-time and can help the seller plan the procurement of materials and manpower given the cash availability. And since digital knows no geographic boundaries, the services of good Factors can now be availed all across India. Invoice Factoring companies now must register with the RBI. Hence there is an added layer of security and transparency, and MSMEs must opt for this model to enhance their business efficiency.