Can factoring help African SMEs with their bills?

In April this year, the African Export-Import Bank and FCI, the global representative body for factoring, hosted a two-day conference in Harare, Zimbabwe. The event focused on how factoring, a form of finance in which businesses sell their invoices to a third party in order to bolster their short-term liquidity, can “empower economic growth” and “serve as a catalyst for the financial inclusion of SMEs [small and medium enterprises]”.

The conference came at a time when the practice of factoring is on the rise in many markets, but has yet to find much of a footing in Africa. Factoring appeals to many businesses because it drastically reduces the amount of time they have to wait to receive payment on their outstanding invoices. While they have to pay a commission to the third party who “buys” the invoice, factoring can help free up firms’ balance sheets, fuelling higher investment and growth.

According to the FCI, the annual turnover for factoring companies globally reached over €2.7 trillion in 2020. However, in 2022, Africa accounted for only around 1% of global factoring volumes – and the small amount of factoring that did take place was disproportionately concentrated in South Africa, Morocco, and Egypt, which together accounted for approximately 98% of African factoring volumes.

Yet to gain traction

Jack-Hermann Ntoko, chief operating officer and co-founder at Paris-based factoring company TradeIn, tells African Business that “factoring has yet to gain much traction in Africa.”

“The main reasons for this include a lack of awareness and understanding of factoring solutions, as well as a lack of regulatory and legal frameworks,” he adds. “Market fragmentation, Africa’s diverse economic conditions, languages, and currencies can make it difficult to implement a unified strategy for factoring services. A lack of supportive institutions such as credit rating agencies and trade associations further impede adoption.”

Ntoko also notes that the African market is viewed as overly risky by the majority of international providers. Firms providing factoring services to African businesses need to be able to conduct due diligence on the companies in question and assess the creditworthiness of their customers to be confident that the invoices will end up being paid. However, limited formal documentation or financial structures means that doing so is often impossible, making the market too risky to enter in the eyes of international firms.

“The financial infrastructure in many African countries is underdeveloped, meaning there is limited access to financial data on companies, such as credit information or how they are using credit insurance and banking services,” Ntoko says.

The African Capacity Building Foundation has similarly said that “the development and use of factoring in the African continent is low due to various challenges, including the lack of a comprehensive facilitative legal and regulatory infrastructure governing factoring transactions in Africa, as well as a lack of awareness on the continent about the product.”

The lack of factoring in Africa is a particular problem for SMEs, which have traditionally found it tricky to access loans or capital from traditional banks on the continent.

In South Africa, for example, only 9% of SMEs are reported to be able to access bank and other private sector financing. In most African markets, banks focus almost entirely on serving large corporations, state-owned enterprises, or high-net-worth clients. International banks operating in Africa have also tended to be reluctant to extend credit to African SMEs, let alone individuals, because they are viewed as too high-risk.

Opportunity for SMEs

In other words, SMEs are desperate for the cash they need to invest and grow – and this is where alternative forms of finance, such as factoring, could play a vital role.

Ntoko tells African Business that “without factoring, businesses face restricted cash flow, making it difficult to invest in operations and expansion. SMEs experience increased financial strain, struggle to cover expenses, and may have to rely on costly loans from other sources.”

“This financial pressure limits their competitiveness and growth potential, as they cannot offer favourable credit terms to customers or take on new projects,” he says. “Furthermore, the lack of factoring means businesses must manage receivables themselves, diverting resources from core operations and increasing the risk of financial distress.”

Several organisations have taken steps to promote the uptake of factoring in Africa. In 2016 Afreximbank launched its “Factoring Model Law” which is designed to help guide African countries in enacting regulations that facilitate factoring. This has since been used as the basis for laws in countries such as Niger and Burkina Faso.

In June last year, Afreximbank also signed a series of deals providing lines of credit totalling €23m to enable factoring companies expand their activities in Africa. Last year the bank also agreed a deal with the global supply chain financing company Fiducia, with both sides pledging to collaborate “to promote factoring across the continent and help reduce the supply chain finance gap”.

While he says that “institutions like Afreximbank have made significant strides in supporting the growth of factoring in Africa,” Ntoko notes that “despite these efforts, the adoption of factoring in Africa remains limited, highlighting the need for continued support and development in this financial sector. This means that the African market is waiting for innovative technological solutions.”

Technology takes off

There are signs that this technology is slowly emerging. For example, fintech companies are increasingly developing solutions allowing financial institutions to onboard African consumers who lack the formal documentation that “know your customer” processes have traditionally relied on. Should such solutions become more widespread, that would be a major step forward in reducing the perceived risk of factoring in Africa and pave the way for higher growth.

With Africa still representing only a miniscule proportion of global factoring volumes, there is clearly a long way to go until the benefits of factoring can start to be unlocked. However, Ntoko is optimistic that the factoring industry could play an important role in contributing to strong and sustainable economic growth on the continent.

Ntoko says that the “adoption of factoring in Africa would yield significant economic benefits, including improved cash flow for businesses, particularly SMEs, enabling them to invest in operations and expansion.”

“This financial flexibility would boost competitiveness and innovation, leading to job creation and economic growth. Enhanced liquidity would also stabilise supply chains, reduce insolvency risks, develop trade credit insurance with more insurance taxes for the government and more revenues for the banks and factors, and attract more investment into the continent,” he adds.

“Overall, factoring could drive sustainable economic development and greater financial inclusion across Africa.”