Factoring
Introduction
• A fund based financial service, provides resources
to finance receivable as well as facilities the
collection of receivables.
• A continuing legal relationship between a financial
institution (the factor) and a business concern (the
client) selling goods or providing services to the
customers on open account basis
• whereby the Factor purchases the client’s book
debts (accounts receivables) either with or without
risk
Why use Factoring?
• Through the use of Factoring receivables are
instantly converted into cash leading to improved
cash flows that can help funding of future growth.
• It facilitate an efficient follow up of payments
from buyers, which is made possible through
relationships developed by factors with client’s
buyers.
• Factoring also provides other peripheral services
such as advisory services, credit assessment, etc.
Functions
• Maintenance /Administration of sales ledger:
• Collection facility:
• Financing trade debts:
• Advisory services:
• Cost of services:
Evolution of factoring
• The term factor has its origin from the Latin
word, ‘Facere’ meaning to get things done.
The dictionary defines a factor as a mercantile
agent.
In India
• Factoring is of recent origin in Indian Context.
Kalyana Sundaram Committee recommended
introduction of factoring in 1989.
• RBI has permitted Banks to undertake factoring
services through subsidiaries.
• Banking Regulation Act, 1949, was amended in
1991 for Banks setting up factoring services.
• SBI/Canara Bank have set up their Factoring
Subsidiaries:- SBI Factors Ltd., (April, 1991)
CanBank Factors Ltd., (August, 1991).
• Specialized factor institutions
SBI Global Factors
Canbank Factors
IFCI Factors
• Commercial banks
HSBC
ICICI Bank
Axis Bank
• Specialized financial institutions : ECGC
Mechanism
• The buyer:
Negotiates terms of purchase with the seller
Receives delivery of goods with invoice and instruction
by the seller to make payment
Make payment to factor *
• The seller:
sales the goods to purchaser
Receives payment from the factor
Also receives balance payment from the factor after
dedication charges
• The factor:
Make payment to seller on receiving of the
document.
Manage sales ledger, collection
TYPES OF FACTORING
1. Recourse Factoring:
If the receivables turn out to be bad, risk of bad debts is to be
borne by the client and the factor does not assume credit
risks associated with the receivables.
the factor acts as an agent only the risk of customer's failure
to pay debt or interest on it. The factor has a right to
recover the funds from the seller client.
The factor charges the selling firm for maintaining the sales
ledger and debt collection services and also charges
interest on the amount drawn by the client (selling firm)
for the period
Non-recourse Factoring
• the risk of non payment by the customers of
the client is to be borne by the factor and he
cannot claim this amount from the selling firm.
• Since the factor bears the risk of non payment,
commission or fees charged for the services in
case of non-recourse factoring is higher than
under the recourse factoring.
• The additional fee charged by the factor for
bearing the risk of bad debts/non-payment.
Advance factoring
• The factor pays a pre-specified portion,
ranging between ¾ to 9/10 of the factored
receivable in advance, the balance being paid
upon collection payment date.
• The client has to pay interest on advance and
fee for managing the accounts
• Bank participation factoring:(75% by factor,
25%/2=12.5% by bank) rest 50% by bank
Maturing factoring
• Factor does not make a pre payment to client.
The payment is made either on the
guaranteed payment date or on the date of
collection.
• guaranteed payment date: fixed on the basis
of previous accounting experience.
Full factoring
• Combination of features of non recourse and
advance factoring it is also know as old line
factoring.
• Services: collection, credit protection, sales
ledger administration and short term finance.
Domestic and Export Factoring
• In the domestic factoring three parties are
involved namely:
1) Customer (buyer)
2) Client (seller)
3) Factor (financial intermediary)
All the three parties reside in the same country.
Export /cross-border/international
factoring
It is almost similar to domestic factoring except
that there are four parties to the factoring
transaction and the countries will be different
of seller and purchaser.
• the exporter (selling firm or client),
• the importer or the customer,
• the export factor and the import factor
• it is also called two-factor system of factoring.
Disclosed and Undisclosed Factoring
• In disclosed factoring the name of the factor is
mentioned in the invoice by the supplier telling the
buyer to make payment to the factor on due date.
• Under undisclosed factoring, the name of the
factor is not disclosed in the invoice. But still the
control lies with the factor.
• The factor maintain sales ledger of the seller of
goods, provides short-term finance against the
sales invoices but the entire transactions take place
in the name of the supplier company (seller).
FORFAITING
• Forfaiting is a means of financing used by
exporters that enables them to receive cash
immediately by selling their medium-
term receivables (the amount an importer owes
the exporter)
• eliminate risk by making the sale without recourse
i.e the exporter has no liability regarding possible
default by the importer on paying the receivables.
Forfaiting vs export factoring
Forfaiting Export factoring
100% 75-90% rest at the end
Avalling bank provides based on credit std. credit
unconditional guarantee extension and credit protection
process of both factors
Pure finance Finance and ledger adm. Credit
collection and so on.
Medium term (3-5 year) Short term
Charge a premium for exchange No exchange rate includes
risk usually
Effective Cost of factoring
=(Net Cost of Factoring/Net Advance Taken)*100
• Net Cost of Factoring= Cost of factoring- Saving Cost.
• Net Advance Taken=
Debtor-reserve-commission=advance- int.
• Cost of factoring=commission +Int.
• Net cost of factoring= cost of factoring –collection
exp. – bad debt
