Factoring and Forfaiting

COMMERCIAL BANKING

TERM PROJECT

Presented By:Rajan A - B12035

Lakshman Singh - B12021Sunil Manchandia - B12051

2013

FACTORING AND FORFAITING

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Agenda

Factoring Steps in Factoring Factoring Process Types of Factoring Pros and Cons of Factoring Factoring Vs. Bank Loan Factoring Vs. Bills Discounting Eligibility and Documentation Factor’s Fees and Expenses Forfaiting Forfaiting Process Costs Involved in Forfaiting Factoring Vs. Forfaiting Comparative Analysis – Bills Discounting, Factoring and Forfaiting

Praxis Business School Factoring and Forfaiting

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Factoring


Factoring can be defined as the conversion of credit sales into cash.

Factoring is a transaction where the exporter sells its receivables to a financial institution which is usually a bank.

The Factoring institution buys the accounts receivable and pays up to 80% of the amount to a company usually a client.

Examples includes factoring against goods purchased, factoring against medical insurance, factoring for construction services etc.

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Parties Involved In Factoring

So, a Factor is, A Financial Intermediary That buys invoices of a manufacturer or a trader, at a discount,

and Takes responsibility for collection of payments.

The factoring transaction involves three parties: Supplier or Seller (Client) Buyer or Debtor (Customer) Financial Intermediary (Factor)


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Steps in Factoring

Customer places the order with client

Client obtains a prepayment limit from factors

Client delivers goods/services to the customers

Copies of invoices, along with a notice to pay submitted to factors

Factors makes a prepayment advance to the client

Factors follows up on payment with the customers

Customer makes payments for factors

Factors makes the balance payment to the client

Step 1

Step 2

Step 3

Step 4

Step 5

Step 6

Step 7

Step 8


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Factoring Process


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International Factoring Process

Source: HSBC


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Types of Factoring

Types of Factoring

Disclosed

Recourse Non-Recourse Maturity Advance

Undisclosed


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Pros and Cons of Factoring

Pros

Receive cash as soon as orders are invoiced

Improves cash cycle Protection from bad debts (if

you choose non-recourse factoring)

Inexpensive way to collect debts

Cons

It can be expensive Hamper relationship with

customers Exiting the agreement can be

difficult


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Factoring Vs. Loan

Factoring is a word often misused synonymously with bank loan.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices).

Factoring differs from a bank loan in three main ways. The emphasis is on the value of the receivables, not the firm’s credit

worthiness. Factoring is not a loan – it is the purchase of an asset (the receivable). A bank loan involves two parties whereas factoring involves three


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Factoring Vs. Bills Discounting

Factoring

Responsibility of collection of Debts

Can be done with or without recourse

Pre-payment made against all unpaid and not due invoices purchased by Factor

Notice of assignment is provided to customers of the Client

credit/ payment risk on factor

Bills Discounting

No responsibility of collection of Debts

Usually done with recourse Bill is separately examined and

discounted No notice of assignment

provided to customers of the Client

Credit risk on client


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Eligibility and Documentation

Factoring Solutions are offered to the following type of concerns Sole Proprietorships Partnerships Private Limited Companies

Other criteria The entity should be in operation for the last 3 years The entity should have generated profits during the last 2 years and should satisfy

our internal credit parameters. The concern must have a positive tangible net worth.

Proof of identity Proof of individual identity Proof of residence address


Source: HSBC India

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Factor’s Fees and Expenses

Commissions: Factors charge commissions for the credit risk they assume and for providing bookkeeping, ledgering, collection and other administrative services to their clients (0.50% to 1.50%)

Commitment fees: Factors typically charge commitment fees at inception of the factoring facility

Interest: Factors charge interest on prepayment

Additional fees: Additional fees may apply in any given factoring agreement. For example, some factors charge minimum monthly discount fees, and early termination fees may also apply if the client wants to terminate the arrangement ahead of its stated expiration date


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Factoring Companies in India

Canbank Factors Limited SBI factors and commercial services Pvt. Ltd HSBC Foremost Factors Limited Global Trade Finance Limited Citibank India Small Industries Development Bank of India (SIDBI) Standard Chartered Bank

HSBC


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Why Factoring Has not become popular in India

Banks’ reluctance to provide factoring services

Bank’s resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines).

Problems in recovery.

Factoring requires assignment of debt which attracts Stamp Duty.

Cost of transaction becomes high


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Forfaiting

The terms forfaiting is originated from a old French word ‘forfait’, which means forfeiting or surrender of right.

Forefaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him.

Forfaiting is a mechanism of financing export Available by discounting export receivable Evidenced by bills of exchange or promissory notes Without recourse to the seller (viz. exporter) Operated on a fixed rate basis (discount) Available upto 100% of the contract value.


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Forfaiting Process


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Pros and Cons of Forfaiting

Pros

100 per cent financing Improves cash flow Reduced administration cost Increased trade opportunity Eliminates the risk of non-

payment Risk elimination (Exchange risk,

and political risks etc)

Cons

It is very expensive (banks take high fees due to high risks)

Not available for short period Not available in financially

week country


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Costs Involved in Forfaiting

Commitment Fee:- Payable to Forfaiter by Exporter in consideration of forfaiting services.

Commission:- Ranges from 0.5% to 1.5% per annum.

Discount Fee:- Discount rate based on LIBOR for the period concerned.

Documentation Fee:- where elaborate legal formalities are involved.

Service Charges:- payable to Bank.

Forfaiting Calculation


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Factoring Vs. Forfaiting

Points of Difference Factoring Forfaiting

Extent of Finance Usually 75 – 80% of the value of the invoice 100% of Invoice value

Finance Short-term finance (90 to 150 days or more)

Long Term Finance (180 days to 7 years)

Credit Worthiness Factor does the credit rating in case of non-recourse factoring transaction

The Forfaiting Bank relies on the creditability of the Avalling Bank.

Services provided Day-to-day administration of sales and other allied services No services are provided

Recourse With or without recourse Always without recourse

Sales By Turnover By Bills


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Comparative Analysis

Bills Discounted Factoring Forfaiting

Scrutiny Individual Sale Transaction

Service of Sale Transaction

Individual Sale Transaction

Extent of Finance Upto 75 – 80% Upto 80% Upto 100%

Recourse With Recourse With or Without Recourse Without Recourse

Sales Administration Not Done Done Not Done

Term Short Term Short Term Medium Term

Charge Creation Hypothecation Assignment Assignment


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THANK YOU


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