For a long time small businesses in the apparel industry have relied on factoring to finance their operations. In fact factoring companies mainly focused their business on the apparel industry before the revolution. However after the great depression, factors diversified their operations to other sectors of the economy. This has forced operators in the apparel industry to compete for the factors’ limited funds with other players in the market.
With these constraints, small companies in the apparel industry have been forced to either close down their businesses or look for alternative sources of finance. Commercial banks which were considered the next best alternative to the factors have not been too generous to them either. This is due to the high risk of financing small businesses.
One of the most viable options for the financing of these small companies is the Community Development Banks. These banks have their focus on small community based businesses. Their products are also designed to meet the needs of such business. In addition they also provide other services such as business advisory services and technical support.
To enhance the operations of the Community Based Development banks, commercial banks should provide additional funds to them. This will be easier for the banks as they do not have to deal directly with these companies. This reduces the administrative costs associated with the financing of grass root organizations. In addition, they can insure these loans to help minimize the risks that arise in case a company is unable to repay the loan.
Community Development Finance Institutions can also be very instrumental in providing financial aid to the small companies in the apparel industry. However for them to be effective they must be provided with financial and technical assistance by the government. This is due to the fact that they have limited resources and cannot therefore be relied upon to finance these companies adequately by themselves.
As mentioned earlier, factoring was the main source of finance for the apparel industry for a long time. Factoring is a financial transaction that entails a business selling its accounts receivable (debtors) at a discount to factor.
Factoring differs from a bank loan in that, first it does not look at a firm’s credit worthiness in lending money but rather at the value of its accounts receivable. Secondly, it involves the purchase of a firm’s short term asset (debtors) and is therefore not a loan. Thirdly, factoring involves three parties; the seller, debtor and the factor. This is unlike a loan which involves only two parties.
In a factoring transaction, the seller trades the debts owed to him at a discount to the trader. The trader then demands the full amount of the debt owed from the debtor. Through this he is able to earn a profit.
Factoring as method of finance has been used for many years and just like any other method, it has its advantages and disadvantages. Among its advantages is that fact that factoring unlocks working capital which is unnecessarily tied up in debts. This is vital for small businesses as it releases capital allowing for their smooth operations and the implementation of their expansion programs.
Factoring also helps to remove the burden of chasing around debtors which is cumbersome and wastes a lot of time and resources. Factors are not as highly regulated as banks. This makes them flexible and therefore their funds are not tied to many conditions unlike banks whose funds have conditions which may affect the normal running of the business. This is important as the sensitive nature of small organizations is not conducive to the interference of its operations especially if it’s in its formative stages.
On the other hand, small companies should limit their use of factoring especially if their profit margin is not adequate to cater for the discount offered. The main aim for setting up a business is to make profits and hence increase the capital base for expansion purposes. Frequent use of factoring therefore beats the logic of setting up the business and poses a threat to the going concern status of the company.
Factoring if not well handled, may also lead to the loss of clients especially if their businesses are also small. Small companies usually have cash flow problems due to their limited resources. The factor may not understand this and may push them so hard that they may become reluctant to do business with the company in future.
In my own opinion, the financing methods chosen by a small apparel company should take into consideration the size of the company and the limited scope of its operations. It should therefore be not very costly as to lead to the closure of the business.
It is a well known fact that small businesses play a very important role in the economic development of any country. To for small companies to expand, they must have access to cheap credit. The interest rates should therefore be low and fixed.
Micro finance institutions operate on these terms and are therefore the best sources of funds for small businesses. The government should therefore provide funds to small businesses though such organizations. This will result in rapid expansion of these companies leading to greater economic development.