This article is about fnance. For other uses, see Factor (disambiguation). Factoring is a fnancial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. In "advance" factoring, the factor provides fnancing to the seller of the accounts in the form of a cash "advance," often 70-85% of the purchase price of the accounts, with the balance of the purchase price being paid, net of the factor's discount fee (commission) and other charges, upon collection. In "maturity" factoring, the factor makes no advance on the purchased accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being purchased in the batch. Factoring difers from a bank loan in several ways. The emphasis is on the value of the receivables (essentially a fnancial asset), whereas a bank focuses more on the value of the borrower's total assets, and often considers, in underwriting the loan, the value attributable to non-accounts collateral owned by the borrower also, such as inventory, equipment, and real property, [1][2] i.e., matters beyond the credit worthiness of the frm's accounts receivables and of the account debtors (obligors) thereon. Secondly, factoring is not a loan it is the purchase of a fnancial asset (the receivable). Third, a nonrecourse factor assumes the "credit risk", that a purchased account will not collect due solely to the fnancial inability of account debtor to pay. In the United States, if the factor does not assume credit risk on the purchased accounts, in most cases a court will recharacterize the transaction as a secured loan. It is diferent from forfaiting in the sense that forfaiting is a transaction-based operation involving exporters in which the frm sells one of its transactions, [3] while factoring is a Financial Transaction that involves the Sale of any portion of the frm's Receivables. [1][2] Factoring is a word often misused synonymously with invoice discounting, known as "Receivables Assignment" in American Accounting ("Generally Accepted Accounting Principles"/"GAAP" propagated by FASB) [2] - factoring is the sale of receivables, whereas invoice discounting is borrowing where the receivable is used as collateral. [2] The three parties directly involved are: the one who sells the receivable, the debtor (the account debtor, or customer of the seller), and the factor. Thereceivable is essentially a fnancial asset associated with the debtor's liability to pay money owed to the seller (usually for work performed or goods sold). The seller then sells one or more of its invoices (the receivables) at a discount to the third party, the specialized fnancial organization (aka the factor), often, in advance factoring, to obtain cash. The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights associated with the receivables. [1][2] Accordingly, the factor obtains the right to receive the payments made by the debtor for the invoice amount and, in nonrecourse factoring, must bear the loss if the account debtor does not pay the invoice amount due solely to his or its fnancial inability to pay. Usually, the account debtor is notifed of the sale of the receivable, and the factor bills the debtor and makes all collections; however, non-notifcation factoring, where the client (seller) collects the accounts sold to the factor, as agent of the factor, also occurs. There are three principal parts to "advance" factoring transaction; (a) the advance, a percentage of the invoice face value that is paid to the seller at the time of sale, (b) the reserve, the remainder of the purchase price held until the payment by the account debtor is made and (c) the discount fee, the cost associated with the transaction which is deducted from the reserve, along with other expenses, upon collection, before the reserve is disbursed to the factor's client. Sometimes the factor charges the seller (the factor's "client") both a discount fee, for the factor's assumption of credit risk and other services provided, as well as interest on the factor's advance, based on how long the advance, often treated as a loan (repaid by set-of against the factor's purchase obligation, when the account is collected), is outstanding. [4] The factor also estimates the amount that may not be collected due to non-payment, and makes accommodation for this in pricing, when determining the purchase price to be paid to the seller. The factor's overall proft is the diference between the price it paid for the invoice and the money received from the debtor, less the amount lost due to non-payment In trade fnance, forfaiting is a fnancial transaction involving the purchasing of receivables from exporters by a forfaiter. The forfaiter takes on all the risks associated with the receivables but earns a margin. [citation needed][1] The forfaiting is a transaction involving the sale of one of the frm's transactions. [1] Factoring is also a fnancial transaction involving the purchase of fnancial assets, but Factoring involves the sale of any portion of a frm's receivables The characteristics of a forfaiting transaction are: Credit is extended to the exporter for a period ranging between 180 days to seven years. Minimum bill size is normally $250,000, although $500,000 is preferred. The payment is normally receivable in any major convertible currency. A letter of credit or a guarantee is made by a bank, usually in the importer's country. The contract can be for either for goods or for services. Merchant banks and investment banks, in their purest forms, are different kinds of financial institutions that perform different services. In practice, the fine lines that separate the functions of merchant banks and investment banks tend to blur. Traditional merchant banks often expand into the field of securities underwriting, while many investment banks participate in trade financingactivities. In theory, investment banks and merchant banks perform different functions. Pure investment banks raise funds for businesses and some governments by registering and issuing debt or equity and selling it on a market. Traditionally, investment banks only participated in underwriting and selling securities in large blocks. Investment banks facilitate mergers and acquisitions through share sales and provide research and financial consulting to companies. Traditionally, investment banks did not deal with the general public. Traditional merchant banks primarily perform international financing activities such as foreign corporate investing, foreign real estate investment, trade finance and international transaction facilitation. ome of the activities that a pure merchant bank is involved in may include issuing letters of credit, transferring funds internationally, trade consulting and co!investment in pro"ects involving trade of one form or another.
The current offerings of investment banks and merchant banks varies by the institution offering the services, but there are a few characteristics that most companies that offer both investment and merchant banking share. #s a general rule, investment banks focus on initial public offerings $IP%s& and large public and private share offerings. Merchant banks tend to operate on small!scale companies and offer creative equity financing, bridge financing, me''anine financing and a number of corporate credit products. (hile investment banks tend to focus on larger companies, merchant banks offer their services to companies that are too big for venture capital firms to serve properly, but are still too small to make a compelling public share offering on a large exchange. In order to bridge the gap between venture capital and a public offering, larger merchant banks tend to privately place equity with other financial institutions, often taking on large portions of ownership in companies that are believed to have strong growth potential A merchant bank is a fnancial institution which provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory on corporate matters to the frms they lend to. Today, according to the US Federal Deposit Insurance Corporation (acronym FDIC), "the term merchant banking is generally understood to mean negotiated private equity investment by fnancial institutions in the unregistered securities of either privately or publicly held companies." [1] Bothcommercial banks and investment banks may engage in merchant banking activities. )ack to top Definition Merchant banks, also known as investment banks, offer various services in international finance and long! term loans for wealthy individuals, multinational corporations, and governments. #n investment bank is split into the so!called front, middle, and back office functions. The front office deals with investment bankingand management, sales and trading, structured products, private equity investment, research, and strategy. The middle office deals with risk management, finance, and compliance. The back office deals with transactions, operations, and technology. The main function of a merchant bank is to buy and sell financial products. They manage risk through proprietary trading, carried out by special traders who do not interface with clients. The trader manages the risk for the principal after they buy or sell a product to a client but does not hedge their total exposure. )anks also try to maximi'e the profitability of certain risk on their balance sheets. Merchant banks manage debt and equity offerings. They assist companies in raising funds from the market. This can include designing instruments, pricing issues, registering offer documents, underwriting support, issue marketing, allotment and refund, and stock exchange listing. They also help in distributing securities such as equity shares, mutual fund products, debt instruments, insurance products, and fixed deposits among others. Merchant banks use a mix of institutional networks*mutual funds, foreigninstitutional investors, pension funds, private equity funds, and financial institutions*and retail networks, depending on how they interact with specific clients. Merchant banks offer corporate advisery services to clients for their financial problems. #dvice may be sought in such areas as determining the right debt!to!equity ratio, the gearing ratio, and the appropriate capital structure. %ther areas of advice may be in areas of refinancing and seeking sources of cheaper funds, risk management, and hedging strategies. +urther areas for advice are rehabilitation and turnaround management. Merchant bankers may design a revival package in con"unction with other financial institutions. Merchant bankers assist clients with pro"ect advice, helping them from the pro"ect concept stage, through feasibility studies to examine a pro"ect,s viability, to the preparation of documents such as a detailed pro"ect report. Merchant banks arrange loan syndication for their clients. This begins with an analysis of the client,s cash flow patterns, helping to determine the terms for borrowing. The merchant bank then prepares a detailed loan memorandum to be circulated to the banks and financial institutions that are to "oin the syndicate. +inally, the terms of lending are negotiated for the final allocation. Merchant banks provide venture capital and me''anine financing $a hybrid of debt and equity financing that is typically used to finance the expansion of existing companies&. In this way they can help companies to finance new and innovative ventures. +ollowing the global financial crisis of -../, which saw the collapse of several prominent investment banks in 0urope and the 1nited tates in eptember of that year, the viability of using a business model that is based heavily on banks purchasing each others, debts has been severely questioned. 2ertainly in the 1nited tates, the view is that this business model is no longer sustainable and is unlikely to continue in the same form in the future. It remains to be seen how merchant banks will restructure in the aftermath of the financial turbulence of -../. )ack to top Advantages Merchant banks perform functions that cannot be carried out by businesses on their own. Merchant banks have access to traders, financial institutions, and markets that companies or individuals could not possibly reach. )y using their skills and contacts, merchant banks can get the best possible deals for their clients. )ack to top Disadvantages Merchant banks are really only for large corporate customers, or extremely wealthy smaller businesses owned by individual clients. 3ot all deals carried out by merchant banks meet with unqualified success. There is always risk attached to the kinds of deal that merchant banks undertake