Trade Credit is Often Extended by Small and Medium Sized Firms (SMEs):

2. Trade Financing – the Extension of Accounts Receivable – Is An Important Source of Financing Around the World

3. Trade Credit is Often Extended by Small and Medium Sized Firms (SMEs):

4. How can a firm convert its (illiquid) Accounts Receivable into Short-Term Financing? "I don’t lend against Assets, I lend against Collateral“ -- CEO of Heller Financial • Receivable Loans • The collateralization of receivables • Requires good collateral law allowing “floating liens”, electronic credit bureaus and registries, strong bankruptcy laws and an efficient judicial environment • Factoring and “Receivables Management” • The sale of receivables

5. WHAT IS FACTORING?? Step 1: “Tiny Textiles (TT)”, a SME, sells 1 million in raw material to its customer “Massive Manufacturer (MM)”, a large multinational exporter. TT (in a competitive gesture) offers MM 30-days trade credit; TT records the sale as 1 million in accounts receivable. Step 2:TT needs working capital to produce more inventory. TT’s only available assets to use for collateral are its accounts receivable from MM. The factor purchases TT’s accounts receivable (TT “assigns” its accounts receivable from MM to the factor.) TT receives today 80% of the face value of the accounts receivable (800,000.) Step 3: In 30 days, the factor receives the full payment from MM, and TT receives the remaining 20% less interest (on the 80%) and service fees.

8. “Ordinary” Factoring • TT sells all its receivables -- from various customers (MM, AA, ZZ, etc.) -- to a factor. • The factor must collect credit information and calculate the credit risk for MM, AA, ZZ, etc.

9. “Reverse” Factoring/ “Receivable Management” • The lender (factor, bank, large firm) pools and purchases accounts receivables payable by MM from many suppliers (including TT) • The lender only needs to collect credit information and calculate the credit risk for MM (a very transparent, internationally accredited firm) • Since the credit risk is reduced, lenders in developing countries can absorb the credit risk and offer factoring “without recourse”

10. An Example • In Argentina, Heller Financial and Walmart have a reverse factoring arrangement -- Walmart offers its suppliers the option to have their accounts automatically “financed” and to receive immediate payment of 80% of the sale (the additional 20% less interest and service charges is paid to the seller upon Heller’s receipt of Walmart’s payment) • The seller may not have any relationship with Heller, yet can receive short-term financing because they are borrowing on Walmart’s credit risk • Heller can raise financing by securitizing its portfolio of Walmart accounts receivable, which has a credit rating equal to that of Walmart

11. Challenges • Taxes (stamp tax, etc.) • Burdensome and costly regulation of non-deposit taking financial institutions • Capital controls that prevent non-banks from holding foreign currency accounts for cross-border assignments • Incomplete credit information

12. Conclusion • “Ordinary” Factoring requires: • Timely and comprehensive credit information • Sophisticated MIS systems • However, “Reverse” Factoring/ Receivables Management only requires complete credit information on 1 or more creditworthy firms • Advantages include: • For the Lender: Low information costs and credit risk • For the (high-risk) Seller: Short-term (and cheaper) working capital financing • For the (creditworthy) Customer: The ability to negotiate better terms with suppliers