FACTORING

INTRODUCTION




Factoring is a financial transaction whereby a
business sells its accounts receivable
(i.e., invoices) to a third party (called a factor) at
a discount in exchange for immediate money with
which to finance continued business.


A study group appointed

INTERNATIONAL INSTITUTE for the Unification
of Private Law (UNIDROIT) ROME 1988 defines:-
factoring means an arrangement between a factor
and his client which includes at least two of the
following services to be provided by the factor-
1) Finance
2) Maintenance of accounts
3) Collection of debts
4) Protection against credit risk
WHY A FIRM USE FACTORING




Factoring is used by a firm when the available
Cash Balance held by the firm is insufficient to
meet current obligations and accommodate its
other cash needs, such as new orders or contracts.
PARTIES INVOLVED IN FACTORING
Client customer
factor
Buyer
collectio
n
SERVICES OFFERED BY A FACTOR

a) Follow-up and collection of Receivables from
Clients.
b) Purchase of Receivables with or without
recourse.
c) Help in getting information and credit line on
customers (credit protection)
d) Sorting out disputes , due to his relationship with
Buyer & Seller.

PROCESS INVOLVED IN FACTORING
a) Client concludes a credit sale with a customer.
b) Client sells the customers account to the Factor and
notifies the customer.
c) Factor makes part payment (advance) against account
purchased, after adjusting for commission and interest
on the advance.
d) Factor maintains the customers account and follows up
for payment.
e) Customer remits the amount due to the Factor.
f) Factor makes the final payment to the Client when the
account is collected or on the guaranteed payment date.

MECHANICS OF FACTORING
a) The Client (Seller) sells goods to the buyer and prepares
invoice with a notation that debt due on account of this
invoice is assigned to and must be paid to the Factor
(Financial Intermediary).

b) The Client (Seller) submits invoice copy only with
Delivery Challan showing receipt of goods by buyer, to
the Factor.

c) The Factor, after scrutiny of these papers, allows
payment (,usually up to 80% of invoice value). The
balance is retained as Retention Money (Margin
Money). This is also called Factor Reserve.


a) The drawing limit is adjusted on a continuous basis after
taking into account the collection of Factored Debts.

b) Once the invoice is honored by the buyer on due date,
the Retention Money credited to the Clients Account.

c) Till the payment of bills, the Factor follows up the
payment and sends regular statements to the Client.

CHARGES FOR FACTORING SERVICES
a) Factor charges Commission (as a flat percentage of value
of Debts purchased) (0. 5 0% to 1. 5 0%)

b) Commission is collected up-front.

c) For making immediate part payment, interest charged.
Interest is higher than rate of interest charged on Working
Capital Finance by Banks.

d) If interest is charged up-front, it is called discount.

TYPES OF FACTORING
a) Recourse Factoring.

b) Non-recourse Factoring.

c) Maturity Factoring.

d) Cross-border Factoring.

RECOURSE FACTORING

a) Up to 75 % to 85 % of the Invoice Receivable is
factored.
b) Interest is charged from the date of advance to the
date of collection.
c) Factor purchases Receivables on the condition that
loss arising on account of non-recovery will be
borne by the Client.
d) Credit Risk is with the Client.
e) Factor does not participate in the credit sanction
process.
f) In India, factoring is done with recourse.

NON-RECOURSE FACTORING
a) Factor purchases Receivables on the condition that the Factor
has no recourse to the Client, if the debt turns out to be non-
recoverable.

b) Credit risk is with the Factor.

c) Higher commission is charged.

d) Factor participates in credit sanction process and approves
credit limit given by the Client to the Customer.

e) In USA/UK, factoring is commonly done without recourse.

MATURITY FACTORING
a) Factor does not make any advance payment to the
Client.
b) Pays on guaranteed payment date or on collection of
Receivables.
c) Guaranteed payment date is usually fixed taking into
account previous collection experience of the Client.
d) Nominal Commission is charged.
e) No risk to Factor.

CROSS - BORDER FACTORING
a) It is similar to domestic factoring except that there are
four parties, viz.,
b) a) Exporter,
c) b) Export Factor,
d) c) Import Factor, and
e) d) Importer.

f) It is also called two-factor system of factoring.
g) Exporter (Client) enters into factoring arrangement
with Export Factor in his country and assigns to him
export receivables.

export Factor enters into arrangement
with

Import Factor has arrangement for credit evaluation &
collection of payment for an agreed fee.
Notation is made on the invoice that importer has to
make payment to the Import Factor.
Import Factor collects payment and remits to Export
Factor who passes on the proceeds to the Exporter after
adjusting his advance, if any.
Where foreign currency is involved, Factor covers
exchange risk also.

Advantages OF FACTORING
Factoring provides a large and quick boost to cash
flow.
Many factoring companies, so prices are usually
competitive.
Assists smoother cash flow and financial planning.
Protected from bad debts ( non-recourse factoring)
Improvement in current ratio
Improves credit rating
Increase in efficiency, reduction in cost


Disadvantages OF FACTORING
It may reduce the scope for other borrowing - book
debts will not be available as security.
Factors will restrict funding against poor quality
debtors or poor debtor spread, so you will need to
manage these funding fluctuations.
It may be difficult to end an arrangement with a
factor as you will have to pay off any money they
have advanced you on invoices if the customer has
not paid them yet.

contd..
Some customers may prefer to deal directly with
you.
The cost will mean a reduction in your profit
margin on each order or service fulfillment.
How the factor deals with your customers will
affect what your customers think of you.
A BUSINESS SUITABLE FOR FACTORING

a) An annual turnover of at least $1 million , but some
factors can also consider start-ups and smaller
businesses.
b) The number of customers should be sufficient.
c) No single customer accounts for more than about a
third of turnover
d) Customers that accept the standard payment terms for
the industry
e) Customers that accept a reasonable period of credit

INDUSTRIES USE IT

a) Transportation
b) Medical
c) Janitorial(the maintenance or cleaning of a building)
d) Staffing
e) Construction
f) Manufacturing
g) Service

FACTORING IN INDIA
a) Kalyana Sundaram Committee recommended
introduction of factoring in 1989.
b) Banking Regulation Act, 1949, was amended in 1991
for Banks setting up factoring services.
c) SBI/ Canara Bank have set up their Factoring
Subsidiaries:-
d) SBI Factors Ltd., (April, 1991) ( an asset base of Rs
1908.00 corers as on March 31, 2008, highest in India)
e) Canara Bank Factors Ltd., (August, 1991).
f) RBI has permitted Banks to undertake factoring
services through subsidiaries.

REASONS FACTORING HAS NOT
BECOME POPULAR IN INDIA
a) Banks reluctance to provide factoring services
b) Banks resistance to issue Letter of Disclaimer (Letter
of Disclaimer is mandatory as per RBI Guidelines).
c) Problems in recovery.
d) Factoring requires assignment of debt which attracts
Stamp Duty.
e) Cost of transaction becomes high.

INTERNATIONAL FACTORING
Step Guide to International Factoring:

The importer places the order for purchase of goods
with the exporter.
The exporter requests the Export Factor for limit
approval on the importer.
Export Factor in turn forwards this request to an Import
Factor in the Importer's country.
The Import Factor evaluates the Importer and conveys
its approval to the Export Factor who in turn conveys
Commencement of the Factoring arrangement to the
Exporter.

The exporter delivers the goods to the importer.
Exporter produces the documents to the Export Factor.
The Export Factor disburses funds to the Exporter up to the
prepayment amount decided and at the same time the
forwards the documents to the Import factor and the
Importer.
On the due date of the invoice, the Importer pays the
Import Factor, who in turn remits this payment to the
Export Factor.
The Export Factor applies the received funds to the
outstanding amount of the advance against the invoice. The
exporter receives the balance payment