Factoring

28/08/2011 1PS NITHYA, Assistant Professor, RVS

College of Engineering and Technology, Coimbatore

FACTORING – MEANING

Factoring is a continuous arrangement between a

financial institution, (factor) and a company (the

client) which sells goods and services to trade

customers on credit.



As per this arrangement, the factor purchases the

client’s trade debts including accounts receivables and

exercises control over the credit extended to the

customers and administers the sales ledger of his client.

The client is immediately paid 80 per cent of the trade

debts taken and when trade customers repay their

dues, the factor will make remaining 20 percent

payment.

A factor is an agent who collects the dues of his client

for a certain fee.28/08/2011 3

PS NITHYA, Assistant Professor, RVS College of Engineering and

Technology, Coimbatore

FACTORING – DEFINITION

According to V.A. Avadhani, “factoring is a service of

financial nature involving the conversion of credit bills into

cash”.







The Process of Factoring or Steps in Factoring

The client sells the goods on credit basis to customers

The client offers the assigned invoice to the factor.

The factor makes a pre-payment up to 80% of the value of the

assigned invoice.

The factor notifies the customer sending a statement of account

Customer remits the amount due to the factor

Factor makes balance 20% of the invoice value to the client when the

account is collected.28/08/2011 7



FUNCTIONS OF FACTORING

Finance

Debt Administration

Credit Risk

Advisory Services



Finance

The factor provides advance money to the client

against outstanding debt of about 80% and the

balance minus commission on maturity.

The factor acts as a source of short-term funds.



Debt Administration

Under this, the responsibility of the factor is to take care of all

the functions relating to the maintenance of the sales ledger

on open item basis which should clearly show all the

outstanding invoices and the unallocated cash.

The factor sends monthly statements of accounts and

informs the client about the progress of collection of debts

from time to time and also informs him/her about the debts

collected and overdue accounts.



Credit Risk

One of the important functions of the factoring is credit

protection.

The factoring organization is required to ascertain the credit

worthiness and feasibility position of several buyers and

accordingly advice the client.

Hence, the client is guided by he factor’s advice in this regard,

under which the factor reduces the risk of loss through bad

debts.



Advisory Services

The factor is also able to provide advisory service

on credit and financial dealings and access to

extensive credit information.



TYPES OF FACTORING

Notified and undisclosed factoring

Recourse and non-recourse factoring

Advance and maturity factoring

Invoice factoring

Buyer-based, seller-based and selective factoring

Export factoring



Notified and undisclosed factoring

In case of notified factoring, the customer is informed about

the assignment of the debt to the factoring agents and is

also asked to pay the dues to the factor instead of to the firm.

On the other hand in the undisclosed factoring, the factoring

arrangements is not disclosed to the customer but the

customer is required to make the payment to the changed

address.

This is also known as non-notified factoring or confidential

factoring.28/08/2011 14



Recourse and non-recourse factoring

In recourse factoring, the factor purchases the receivables

on the condition that the loss arising on account of

irrecoverable receivables will be borne by the client.

In non-recourse factoring the bad debts are borne by the

factoring agent. Since the factor bears the loss arising on

account of irrecoverable debts, the factor charges a higher

commission.



Advance and maturity factoring

In advance factoring, the factor provides an advance

varying between 75-85% of the value of receivables

factored and the balance is paid upon collection or on

the guaranteed payment date.

In maturity factoring, the factor makes the payment on

a guaranteed payment date or on the date of

collection.





Buyer based Factoring

• In most case, the factor is acting as an agent of the

seller. But under this type, the buyer approaches

a factor to discount his bills. Thus the initiative

for factoring comes from the buyer end.





Export factoring

This is also known as international factoring or cross border

factoring.

Export factoring houses deal with export sales and provide

financial service, collection service, advisor service, and service

for completing legal formalities pertaining to export.

Export factoring is quite helpful to small exporters and new

entrants to export business in India.





BILL DISCOUNTING Vs FACTORING• Under Factoring, the factor purchases the trade debt & thus becomes a

holder for value. Under discounting the financier acts simply as an agent of

his customer & he does not become the owner.

• The Factors may extend credit without any recourse to the client in the

event of non-payment by customers. But, discounting is always made with

recourse to the client.

• Account receivables under discount are subject to rediscounting whereas it

is not possible under Factoring



• Factoring involves purchase and collection of debts,

management of sales ledger, assumption of credit risk,

provision of finance & rendering of consultancy services, But

under Bill discounting only discounting function takes place.

• Discounting is always a kind of “in-Balance sheet financing”

that is both the amount of receivables & bank credit are

shown in the balance sheet itself due to its with recourse

‘nature But, Factoring is always “Off-Balance Sheet

Financing” .28/08/2011 23



Benefits of factoring to the Clients

Financial services

Collection services

Credit risk service

Provision of expertise sales

ledger management service

Consultancy service

Economy in servicing

Off-Balance sheet financing

Trade Benefits

Miscellaneous service



Financial Service Many of the manufacturers and traders find their working

capital being locked up in the form of trade debts. This has been a great handicap to the small and medium

scale manufacturers. Many business concerns fail more as a result of inadequate

cash flow than anything else. The major benefit of the factoring service is that the clients

will be able to convert their trade debts into cash up to 80% immediately as soon as the credit sales are over.

The greatest advantage is that factoring assures immediate cash flow.

When the cash position improves, the client is able to make his purchases on cash basis and thus, he can avail of cash discount facilities also.



Collection services Collection of debts is another problematic area for many

concerns. Collection of debts becomes an important internal credit

management and it requires more and more time. delay in collection process often leads to delay in

production and supplies. Now, this collection work is completely taken up by the

factoring organisation, leaving the client to concentrate on production alone.

The cost of collection is also cut down as a result of the professional expertise of a factor.



Credit risk service Bad debts eat away the profits of a concern and in some

cases, it may lead to the closure of a business. once the factoring relationship is established, the client

need not bother about the loss due to bad debts. The factor assumes the risk of default in payment by

customers and thus, the client is assured of complete realisation of his book debts.

Even if the customer fails to pay the debt, it becomes the responsibility of the factor to pay that amount to the client.

It is the greatest advantage of factoring.



Provision of expertised sales ledger management service

The success of any organisation depends upon the efficiency with which the sales ledger is managed.

It requires a specialised knowledge which the client may not possess.

The client can receive services like maintenance of accounting records, monthly sales analysis, overdue invoice analysis and customer payment statement from the factor.

It becomes the factor’s responsibility to take care of all the functions relating to the maintenance of sales ledger.



Consultancy Service

Factors are professionals in offering management services like consultancy.

They collect information regarding the credit worthiness of the customers of their clients, ascertain their track record, quality of portfolio turnover, average size of inventory etc., and pass on the same to their clients.

It helps the clients avoid poor quality and risky customers.



Economy in Servicing

Factors are able to render very economic service to their clients.

Their service charges are also reasonable. Factoring is a cheap source of finance to the

client because the interest rate is charged only on the amount actually provided to the client.

Clients are able to get factoring services at economic rates.



Trade Benefits Availability of ready cash against bills enables

the supplier to negotiate better prices for the inputs and also offer finer terms to customers.

It ensures a steady flow of inputs on the one hand and better market prospects on the other.

Factoring enables the supplier to concentrate on production and materials management without bothering about the financial management.

Factoring enables clients to offer longer credit facilities to their customers and thus to attract more business.



Miscellaneous Service

Factors are able to computerise their operations fully.

They are able to render prompt service at reasonable rates.

They also build bigger credit library of debtors by means of collecting information about new debtors.



Off-Balance Sheet Financing Factoring is an off-balance sheet means of

financing. When the factor purchases the book debts of

the client, these debts no longer exist on the current assets side of the balance sheet.

It leads to reduction in debts and less collection problems.

The client can utilise the money so received to reduce his current liabilities.

It means an improved current ratio.



FACTORING IN INDIA

In Indian context, factoring is being viewed as a source of short-term

finance that can offer useful services specially to the supplier.

SBI is the first factoring company to be set up in India.

It was incorporated in February 1991 and it commenced its business

operations from April 1991.

SBI factors, a subsidiary of the SBI, is one of the leading factoring

companies in India.



FACTORING COMPANIES IN INDIA

• SBI Factors and Commercial Services Pvt. Ltd – March

1991 with paid up of Rs 25 crores.

• Can bank Factors Limited – August 1991 with paid up of

Rs 10 crores was contributed by Canara Bank, Andhra

Bank and SIDBI

• Fair Growth Factors – First Private Sector Company in

April 1992 with paid up of Rs 5 crores



• Foremost Factors Limited – 1997 – Joint venture

between the Mohan Exports and the Nations Bank

Overseas Corporation(USA), 20th Century Finance

Corporation and the ICDs group.

• Global Trade Finance Limited -September 2001, as a

joint venture promoted by Export Import Bank of India

(Exim Bank); West LB, Germany; and IFC, Washington

(the private sector arm of World Bank).



• The Hong Kong and Shanghai Banking Corporation Ltd

• Export Credit Guarantee Corporation of India Ltd

• Citibank , India

• Small Industries Development Bank of India (SIDBI)



INTERNATIONAL FACTORING

Factoring is a global industry with vast turnover.

It offers various advantages such as consistent cash flow, lower

administration costs, reduced credit risks and more time for core activities.

It is now universally accepted as vital to the financial needs of particularly

small and medium sized business.

Factoring become well established in developing countries as well as in

highly industrialized countries.



International Factoring contd., International factoring works in a similar way to domestic factoring.

In various Asian countries, the growth of factoring has been dramatic.

A similar growth has occurred in Central Europe and the Middle East.

For many companies, selling in an international market place is the

ultimate challenge.

The role of factor is to collect money owed from abroad by approaching

importers in their own country, in their own language and in the locally

accepted manner.



International Factoring contd., Globally, many businesses with millions of customers avail the facilities

provided by factoring companies to settle their trade receivables.

The goods can be sold on open account terms and factor provides

professional help with credit control, debt collection and sales accounting.

A factor can also provide exporters with 100% protection against the

importer’s inability to pay.

The advantages of export factoring have proved to be very attractive to

international traders.



International Factoring contd.,

In international factoring there are usually two factors.

The export factor looks at financing the exporter and sales administration.

The import factor is interested in evaluating the buyer, collecting the money

on time, at the same time ensuring that he is protected against default.

International factoring encompasses all the four services, that is pre-

payment, sales ledger administration, credit protection and collections.



PROCESS IN INTERNATIONAL FACTORING1. The importer places the order on the exporter.

2. The exporter conveys his approval to his bank. The exporter’s bank conveys the

approval to the importer’s bank.

3. The exporter delivers the goods to the importer.

4. The exporter produces the documents before his bank.

5. He receives prepayment; at the same time, the exporter factor gives documents to the

importer’s factor and the importer

6. The importer pays his factor

7. The import factor pays the export factor.

8. The exporter receives the balance payment.



Benefits of International Factoring to Exporters

Increased sales in foreign markets by offering competitive

terms of sale

Protection against credit losses on foreign customers

Accelerated cash flow through faster collections

Lower costs than the aggregate charges for L/C transactions

Liquidity to boost working capital



Factor Chain International (FCI)

FCI is a global network of leading factoring companies,

whose common aim is to facilitate international trade

through factoring and related financial services.



FORFAITING• In international trade, the selling of an exporter's

receivables for a particular transaction. It is similar to

factoring except in scope. While a company sells all of its

accounts receivable in factoring, an exporter only sells

one receivable for one, In forfaiting, the buyer is known as

a forfaiter, and assumes all the risks associated with

collecting the receivables. Generally, the exporter forfaits

the receivable at a discount. This improves cash flow but

reduces income.





Details are as under :

1) Commercial contract between exporter and importer.

2) Delivery of goods by exporter to importer on credit.

3) Contract between importer and his bank to have

guarantees which will be given in respect of payment

against negotiable instrument on due date.

4) Delivery of negotiable instrument either bill of exchange

or promissory note to the exporter.



5 & 6) Forfaiting contract between exporter and forfaiter under

which negotiable instrument will be endorsed without recourse

in favour of the forfaiter.

7) Cash payment of discounted for negotiable instrument by

forfaiter to exporter (face value of bill less discount amount).

8) Presentation of negotiable instrument to the importer’s bank.

9) Payment on presentation of negotiable instrument on maturity.



FORFAITING SERVICES IN INDIA

• Recognizing the utility of Forfaiting services to Indian

exporters, the RBI decided to make available such

services to the exporters.

• At the beginning the RBI authorized EXIM Bank in 1992

to offer Forfaiting services. The role of the EXIM Bank

has been that of a facilitator between the Indian

exporter and the overseas Forfaiting agency.



FACTORING Vs FORFAITING• Factoring services is mainly meant for financing and collecting of

receivables arising from short term credit transactions say upto 180

days. As against this, Forfaiting is meant for financing credit

transactions of having deferred credit period of more than 1 year.

• Factoring arrangement can be with recourse or without recourse

depending on the terms of factoring contract between a client and a

factor. As against this, Forfaiting transaction is always without

recourse where forfeiter absorbs credit risk also.



• Factoring services can be considered either for domestic transaction

or for export transaction. As against this Forfaiting transaction is always

considered for export transactions only.

• Factoring is done on the strength of sales invoices only. Whereas

Forfaiting involves use of negotiable instruments like bill of exchange or

promissory note.

• In a factoring arrangement, a margin of 5 to 20 per cent is kept. In other

words, finance is provided immediate on the purchase of invoice to the

extent 80 to 95 per cent of invoice value. As against this; a forfaiter

discounts the entire sale value of the export transaction without keeping

any margin.28/08/2011 51



• Factoring services include sales ledger,

administration, collection of receivables and other

advisory services. On the other hand, Forfaiting is a

pure financial arrangement.

• Factoring is done on whole turnover basis, whereas,

Forfaiting can be done on transaction basis.





Factoring

Documents

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factoring meaning factoring

advance factoring

rvs college of engineering

assistant professor

confidential factoring

types of factoring

factoring definition