By Joyce Yao (China Minsheng Bank)
In the conventional sense, factoring should be adapted for the industry like international or domestic commodity trade which payment terms are relatively short and goods delivery is quite certain. However, along with rapid development of large-scale engineering and construction industry in China, there are a lot of business demands arisen from construction industry. In the whole supply chain of construction projects, there are huge amounts of accounts receivable which brought the factoring business opportunities. The payment terms in construction industry are usually long, so most of the suppliers and construction companies have great financial pressure. This presents tremendous business opportunity for factors to provide ‘Construction Factoring’.
CHINA’S DOMESTIC FACTORING IN THE CONSTRUCTION INDUSTRY
Factoring in China was shown to be the appropriate financial product for engineering and construction industry.
The participants in engineering and construction projects will constitute a very complicated supply chain. There are great number of participants involved in the whole supply chain, which include raw material suppliers, subcontractors, general contractors, project owner and others. Accounts receivable are existing in each link of the chain, and each participant might be the applicant of factoring business. Factoring can be based on the accounts receivables between suppliers and buyers involved in the purchase of raw materials, accounts receivable between subcontractors and contractors, and accounts receivable between general contractors and project owners.
SUPPLIER => CONTRACTORS => PROJECT OWNER
The payment stage involved in the construction project is relatively complicated. Usually, the payment can be divided into 4 stages, advance payment, progress payments, completion
acceptance payment, and retention. Advance payment and quality retention are not fit for factoring, while the progress payment and completion acceptance payment are suitable. The construction project usually takes years to complete. The project supervisor assesses the value of the work each month or at the set period. The buyer issues the invoice in stages for the construction progress that the seller has done according to schedule, and will agree in the contract to pay at a specified date in future. Then those kinds of accounts receivable can be assigned to factors and get factoring service.
Stage Project payment schedule % of total amount Can do factoring or not
Stage 1 Advance payment Around 10%-30% No
Stage 2 Progress payment Around 50%-70% Yes
Stage 3 Completion acceptance payment Around 20%-30% Yes
Stage 4 Quality Retention payment Less than 5% No
The factoring products applied in the construction industry are diversified. The classic mode is recourse factoring, that is, the construction company (the seller) will assign the receivables of progress payment or completion acceptance payment to the factor, and the factor will provide recourse factoring service to the seller, including advance payment and collection of A/R. If the debtor has a very good credit rating, the factor could be able to approve the credit line for the debtor, and provide non-recourse factoring to the seller. In addition, reverse factoring is widely used in the construction industry to meet the financing needs from suppliers. In this case, factoring business is initiated from the debtor. Based on the debtor’s confirmation of accounts payable, the suppliers could sign the factoring agreement with the factor, assign the receivables and then get advance payment financing.
INNOVATION OF FACTORING IN ONE BELT ONE ROAD
Since the “one belt and one road” strategy, the total accounts receivable of overseas construction projects of Chinese enterprises have been increasing. Cross-border construction factoring is an important way to solve the financing problem of overseas project contractors. Overseas construction projects are having more uncertainty. On the one hand, the bank factors are cooperating with Sinosure (China Export and Credit Insurance Insurance Corporation) to cover country risk and buyer credit risk. On the other hand, the bank factors also set a high entry criteria for those contractors, who need to have a very strong qualification and contractual capacity.
China’s practical experience in construction factoring might have significance to the expansion of international factoring. Chinese factors are also making efforts on continuous innovation, such as factoring in financial leasing business and other industries. It is hoped that global financial institutions can participate in the innovative business and develop more opportunities together.