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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.
28/08/2011 2PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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”.
28/08/2011 4PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 5PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 6PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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
PS NITHYA, Assistant Professor, RVS College of Engineering and
Technology, Coimbatore
FUNCTIONS OF FACTORING
Finance
Debt Administration
Credit Risk
Advisory Services
28/08/2011 8PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 9PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 10PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 11PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
Advisory Services
The factor is also able to provide advisory service
on credit and financial dealings and access to
extensive credit information.
28/08/2011 12PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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
28/08/2011 13PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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
PS NITHYA, Assistant Professor, RVS College of Engineering and
Technology, Coimbatore
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.
28/08/2011 15PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 16PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 17PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 18PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 19PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 20PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 21PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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
28/08/2011 22PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
• 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
PS NITHYA, Assistant Professor, RVS College of Engineering and
Technology, Coimbatore
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
28/08/2011 24PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 25PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 26PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 27PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 28PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 29PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 30PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 31PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 32PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 33PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 34PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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
28/08/2011 35PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
• 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).
28/08/2011 36PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
• The Hong Kong and Shanghai Banking Corporation Ltd
• Export Credit Guarantee Corporation of India Ltd
• Citibank , India
• Small Industries Development Bank of India (SIDBI)
28/08/2011 37PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 38PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 39PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 40PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 41PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 42PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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
28/08/2011 43PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 44PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 45PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 46PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 47PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 48PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 49PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
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.
28/08/2011 50PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
• 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
PS NITHYA, Assistant Professor, RVS College of Engineering and
Technology, Coimbatore
• 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.
28/08/2011 52PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore
28/08/2011 53PS NITHYA, Assistant Professor, RVS
College of Engineering and Technology, Coimbatore