FACTORING

INTRODUCTION

Factoring, as a fund based financial services, provides resources to finance receivables as well as facilitates the collection of receivables. Although such services constitute a critical segment of the financial services scenario in the advanced countries. They appear on the Indian financial scene only in early nineties as a result of RBI initiatives.

MEANING
Factoring involves the outright sale of receivables at a discount to a factor to obtain funds.

Factor is a financial institution that specialize in purchasing receivables from business firms.

Factoring means an agreement between a factor and his client which includes at least two of the following services provided by the factor: Factor Maintenance of accounts Collection of debt Protection against credit risk.

Factoring can broadly be defined as an agreement in which receivables arising out of sale of goods/services presented by the said receivables passes on to the factor. Henceforth ,the factor becomes responsible for all credit control, sales accounting and debt collection from the buyer.

Definition :It is defined as the relationship , created by an agreement, between the seller of goods / services and a financial institution called the factor, whereby the later purchases the receivables of the former and also controls & administers the receivables of the former.

Nature :
It is a service of financial nature involving the
conversion of credit bills into cash. The risk associated with credit are taken over by the factor. It is a financial institution which offers services relating mgt. & financing of debts arising out of credit sales. Payments are received by the factor directly since the invoices are assigned in favor of the factor.

Contd..
A factor performs at least two of the following functions:
i) Providing finance to supplier. ii) Maintains accounts ,ledgers relating to receivables. iii) Collects receivables. iv) Protects risk of default in payments by debtor.

Factor is responsible for sales accounting, debt collection & credit control protection from bad debts etc. It is a tool of receivable management.

MECHANISM
An agreement is entered into b/w the selling firm & the factor firm. The sales documents should contain the instructions to make payments directly to the factor. After receiving the payment, the account of selling firm is credited by the factor after deducting its all charges The factor may also provide advance finance if the conditions of the agreement so require.

PROCESS :
SALE OF GOODS(2)

Agreement(1)

Selling Firm

FACTOR

CUSTOMERS RECEIVABLES

INVOICE COPY(3) Advance payment/ Discounting(4) FINAL PAYMENT AFTER DEDUCTING FEES AND CHARGES, IF ANY (5)

PAYMENTS

Parties to the Factoring

The buyer
(a) Buyer negotiates terms of purchasing the material with the seller. (b) Buyer receives delivery of goods with invoice. (c) Buyer make payment to factor on time or get extension of time or in case of default is subject to legal process at hands of factor.

THE SELLER
(a) (MOU) with the buyer in form of letter exchanged between them or agreement entered in to between them (b) Sell goods to the buyer as per MOU (C) Deliver copies of invoice (d) Seller receives 80 per cent or more payment in advance.

THE FACTOR:
(A)The factor enters into agreement with seller for rendering factor services to it. (B)On receipt of copies of sales documents. (C)The factor receives payment from the buyer on

TYPES/FORMS OF FACTORING
Recourse and Non-recourse factoring Advance and Maturity factoring Conventional or Full factoring Domestic and export Factoring Limited Factoring Selected Seller/Buyer Based Factoring Disclosed and Undisclosed Factoring

Recourse Factoring-is the basis on which receivables are sold to the factor with the understanding that all credit risks would be borne by the firm. Non recourse Factoring- is the basis on which receivables are sold to the factor with the understanding that all credit risks would be on the purchased accounts (factor).

Advance Factoring- The factors pays pre specified portion , ranging between threefourths to nine-tenths, of the factor receivables in advance, the balance being paid upon collection/on the guaranteed payment date. Maturity Factoring /collection factoring-is an arrangement under which the factor does not make prepayment to the client.

FULL FACTORING
This is most comprehensive form of factoring combining the features of almost all the factoring. it is also known as old line factoring. Full factoring provides the entire spectrum of services, namely, collection, credit, protection, sales ledger administration and short term finance.

DISCLOSED FACTORING
In disclosed factoring , the name of the factor is disclosed in the invoice by the supplier-manufacturer of the goods asking the buyer to make payment to the factor. Undisclosed factoring : the name of the factor is undisclosed in the invoice in undisclosed factoring although the factor maintains the sales ledger of supplier manufacturer.

DOMESTIC AND EXPORT/CROSS BORDER /INTERNATIONAL FACTORING

FUNCTIONS OF A FACTOR
Maintenance / administration of sales
ledger Collection of receivables purchased Provision of Finance Protection against risk of bad-debts Provision of advisory services

COST OF SERVICES :
1. Administrative charges/ factoring fees :
This charge is usually some percent of the projected sales turnover of the client for the next 12 months. It varies b/w 1 to 2.5 % of the projected turnover.

2. Discount Charges :
This is levied towards instant credit to the client by way of prepayment.

ADVANTAGES
Improved efficiency ratio Higher credit standing Better Production and purchase planning Reduction of cost and expenses Provides flexibility to the company Better position to meet its commitments Meet seasonal demands

LIMITATIONS :
Led to overconfidence & mismanagement Lack of professionalism & competence Uncertain Rights Not suitable for every concern.

STATUTES APPLICABLE TO FACTORING

Factoring transactions in India are governed by the following Acts:Indian Contract Act Sale of Goods Act Transfer of Property Act Banking Regulation Act. Foreign Exchange Regulation Act.

a)

b)

c)

d)

e)

WHY FACTORING HAS NOT BECOME POPULAR IN INDIA

Banks reluctance to provide factoring services Problems in recovery. Factoring requires assignment of debt which attracts Stamp Duty. Cost of transaction becomes high.

Bills Discounting Vs. Factoring

Provision of finance against bills. Advances are paid against bills Drawer undertakes the responsibility only. They may be rediscounted again & again It is always with recourse.

It renders all services including finance. Trade debts are purchased by agreement. It undertakes to collect the bills of the client. They can only be refinanced and not rediscounted. It may be with or without recourse.

Contd..

It involves individual transaction of bill In Balance-Sheet Item It is always disclosed , as acceptor of bill has full knowledge

It involves bulk transaction of whole turnover Off-Balance-Sheet Item. It is generally Undisclosed & confidential in nature.

FORFAITING :The forfaiting owes its origin to a french term a forfait which means to forfeit ones right on something to someone else. It is a mechanism of financing exports ; a) by discounting export receivables b) evidenced by bills of exchange c) carrying medium to long-term maturities d) on a fixed rate basis up to 100% of the contract value.

FEATURES
In pursuance of a commercial contract between an exporter sells and delivers the goods to the importer on a deferred payment basis. The importer draws a series of promissory note in favour of the exporter for payment including interest charge. The exporter enters in to a agreement with a forfaiter which is usually a reputed bank. Payment to forfaiter to the exporter.

The forfaiter may hold these notes /bills till maturity for payment by the importer bank.

FACTORING V/S. FORFAITING

Factoring refers to domestic bills-purchase & discount No letter of credit or bank guarantee is required. Factor finance 75-85% of the receivables. It may be with or without recourse Short-term in nature involving credit period upto 180 days.

Forfaiting refers to discounting of foreign credit bills. Letter of credit or bank guarantee is required. In Forfaiting 100% finance is available Pure financing arrangement. Always without recourse Medium to long term in nature involving credit of 180 days to 7 yrs.

Contd

It is a continuous arrangement. All sales are routed by client through factor. Applicable to both domestic and export receivables.

Deals are concluded transaction-wise.

Available usually for export receivables.