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PS 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.

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PS NITHYA, Assistant Professor, RVS College of Engineering and Technology, Coimbatore

As per this arrangement, the factor purchases the

clients 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.
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FACTORING DEFINITION
 According to V.A. Avadhani, factoring is a service of financial nature involving the conversion of credit bills into cash.

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PS 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.NITHYA, Assistant Professor, RVS PS

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FUNCTIONS OF FACTORING
 Finance  Debt Administration Credit Risk Advisory Services

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PS 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.

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PS 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.
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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 factors advice in this regard,

under which the factor reduces the risk of loss through bad debts.
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Advisory Services
 The factor is also able to provide advisory service
on credit and financial dealings and access to extensive credit information.

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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
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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.
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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.
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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.

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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.

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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.

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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
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 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 .
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Benefits of factoring to the Clients

 Financial services  Collection services  Credit risk service  Provision of expertise sales  Economy in servicing  Off-Balance sheet financing  Trade Benefits  Miscellaneous service

ledger management service

 Consultancy service
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Financial Service
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.
PS NITHYA, Assistant Professor, RVS College of Engineering and Technology, Coimbatore

 Many of the manufacturers and traders find their working

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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.
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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.
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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.
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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.
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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.
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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.
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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.

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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.
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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.
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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
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 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).
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 The Hong Kong and Shanghai Banking Corporation Ltd Export Credit Guarantee Corporation of India Ltd Citibank , India Small Industries Development Bank of India (SIDBI)

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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.Professor, RVS PS NITHYA, Assistant

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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

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and in the locally accepted manner.

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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

importers inability to pay.

 The advantages of export factoring have proved to be very attractive
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to international traders.

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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

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collections.

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PROCESS IN INTERNATIONAL FACTORING

1. 2. The importer places the order on the exporter. The exporter conveys his approval to his bank. The exporters bank conveys the approval to the importers bank. 3. 4. 5. The exporter delivers the goods to the importer. The exporter produces the documents before his bank. He receives prepayment; at the same time, the exporter factor gives documents to the importers factor and the importer 6. 7. The importer pays his factor The import factor pays the export factor.
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8. The exporter receives the Engineering and Technology, 28/08/2011 College of balance payment.

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

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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.

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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.
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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.
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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 importers bank. 9) Payment on presentation of negotiable instrument on maturity.

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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.
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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.
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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
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any margin.

 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.

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