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What is factor?
A company can assign its credit
management and collection tospecialist organisations called the
factor organisation or the factor.
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Factoring
Definition:
Factoring is defined as a continuing legalrelationship between a financial institution
(factor) and a business concern (client)selling goods or providing services to tradecustomers (customer) whereby, the factorpurchases the clients accounts
receivables and in relation thereto,controls the credit, extended to customersand administers the sales ledger.
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In Normal Business
CLIENT
(Supplier of
goods and/or
Services)
CUSTOMER
(Buyer of
goods and/or
Services)
Using Factoring
CLIENT
(Supplier of
goods and/or
Services)
CUSTOMER
(Buyer of
goods and/or
Services)
FACTOR
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Functions of factor
Finance for the supplier, including loansand advance payments.
Maintenance of accounts.
Collection of accounts.
Protection against default in payment bydebtors.
Issuing notice of assignment of thereceivables to debtors.
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Mechanism of factoring
There are three parties to a domestic
factoring arrangement:
The client who is supplier or seller of goods and
services.
The customer who is a debtor or buyer of goodsand services provided by the client.
The factor who is a financial institution orintermediary between client and customer who
provides the factoring services.
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Different factoring services
Sales ledger administration and credit
management.
Credit collection and protection againstdefault and bad debt losses.
Financial accomodation / assistance
agaist the assisned book debts.
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Different factoring services contd.
1. Credit administration/ management
Helps and advices the clients from the stage ofdeciding credit extension to customers to thefinal stage of bad debt collection.
Factor maintains an account for customers ofall items owing to them , so that collectioncould be made on due date or before.
Helps clients to decide whether to give ornotand, how much credit extent to the customers
Provides info to clients about market trends ,competition, and creditworthiness of customer.
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Different factoring services
contd.2. Credit collection and protection againstdefault
Factor undertakes all collection activitywhen individual book debts become duefrom the customer
Provides full or partial protection agaistbad debts
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Different factoring services contd.
3. Financial assistance/ accomodationagainst the assigned book debts
Factors provide financial assistance tothe clients by extending advance cashagainst book debts
Purchase the debts , allowing full creditprotection against any bad debts andprovide assistance against firms bookdebts
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Types of factoring servicing
Full service non-recourse (old line)
Full service recourse factoring
Bulk/agency factoring
Non-notification factoring.
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Full service non-recourse.
Factor undertakes to collect the debts from the
customer assuming 100 % risk.
Balance amount is paid to client at the end of
the credit period or when the customer pays thefactor whichever comes first.
The advantage of non recourse factoring is that
continuous factoring will eliminate the need for
credit and collection departments in the
organization.
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Full service recourse factoring
Client undertakes to collect the debts from the
customer.
If the customer don't pay the amount on
maturity, factor will recover the amount from theclient.
This is the most common type of factoring.
Recourse factoring is offered at a lower interestrate since the risk by the factor is low.
Balance amount is paid to client when the
customer pays the factor.
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Bulk/agency factoring
Also called disclosed factoring .
client's customers are notified of thefactoring agreement.
Disclosed type can either be recourse or
non recourse
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Non-notification factoring
Also called undisclosed factoring.
Client's customers are not notified of the
factoring arrangement.
Sales ledger administration and collection of
debts are undertaken by the client himself.
Client has to pay the amount to the factor
irrespective of whether customer has paid or not.But in disclosed type factor may or may not be
responsible for the collection of debts depending
on whether it is recourse or non recourse.
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Checking credit worthiness
Factor evaluated creditworthiness of the customer(buyer of goods).
Checking credit informationUsing :-
balance sheets, p/l account
Banks reference
Traders reference
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Credit limit
Credit limit is maximum credit which firmwill extend at any point of time.
The decision will depend upon thecustomer financial strengths.
The credit limit must be reviewed
periodically.
The firm should follow well laid downcollection policy.
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Example..
Siemens( India) sells about 85% of its
products through dealers and remaining
15% is sold directly to large corporate
customers. generally a 45 day credit is
extended to dealers but a lot of variation
exist for different dealers.
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Cost of factoring
These are two types of costs in factoringservices
1. Service Fee orCharges
Service fee is levied for the work involved inadministering the sales ledger as well as protection
against bad debts. The service fee for domestic factoring ranges from0.30 per cent to 0.75 per cent and it would be higherwhen non-recourse arrangements are made.
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Cost of factoring contd.
2. Discount Charge
The discount charge is levied on the advance providedby the factor and is computed on the basis of primelending rate.
It is calculated on a day-to-day basis on the advancesoutstanding,
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Benefits of factoring
The client will be relieved of the workrelating to sales ledger administration anddebt collection.
The client can therefore concentrate moreon planning production and sales.
Firm can save the cost of credit
administration.For the purpose of preventing defaults and
bad debts.
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Image of the client may suffer as engaging afactoring agency is not considered good sign ofefficient management.
Factoring may not be much use wherecompanies or agents have one time sales withthe customers.
Factoring increases cost of finance & thus cost ofrunning the business.
If the client has cheaper means of finance &
credit, factoring may not be useful.
Disadvantages ofFactoring
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Thanks