FACTORING

WHAT IS FACTORING ?
Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on the understanding that the Factor will pay for the Book Debts as and when they are collected or on a guaranteed payment date. Normally, the Factor makes a part payment (usually upto 80%) immediately after the debts are purchased thereby providing immediate liquidity to the Client.

PROCESS OF FACTORING

CLIENT

CUSTOMER

FACTOR

So, a Factor is,

a) b)
c)

A Financial Intermediary That buys invoices of a manufacturer or a trader, at a discount, and Takes responsibility for collection of payments.

The parties involved in the factoring transaction are:-

a) b) c)

Supplier or Seller (Client) Buyer or Debtor (Customer) Financial Intermediary (Factor)

SERVICES OFFERED BY A FACTOR

1. 2.

Follow-up and collection of Receivables from Clients. Purchase of Receivables with or without recourse.

3.
4.

Help in getting information and credit line on customers (credit protection)

Sorting out disputes, if any, due to his relationship with Buyer & Seller.

PROCESS INVOLVED IN FACTORING

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

MECHANICS OF FACTORING
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). receipt of goods by buyer, to the Factor.

The Client (Seller) submits invoice copy only with Delivery Challan showing The Factor, after scrutiny of these papers, allows payment (,usually upto 80%
of invoice value). The balance is retained as Retention Money (Margin Money). This is also called Factor Reserve.

The drawing limit is adjusted on a continuous basis after taking into account
the collection of Factored Debts.
credited to the Clients Account.

Once the invoice is honoured by the buyer on due date, the Retention Money Till the payment of bills, the Factor follows up the payment and sends regular
statements to the Client.

CHARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to 1.50%) Commission is collected up-front. For making immediate part payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks. If interest is charged up-front, it is called discount.

TYPES OF FACTORING

Recourse Factoring
Non-recourse Factoring Maturity Factoring Cross-border Factoring

RECOURSE FACTORING
Upto 75% to 85% of the Invoice Receivable is factored. Interest is charged from the date of advance to the date of collection. Factor purchases Receivables on the condition that loss arising on account
of non-recovery will be borne by the Client.

Credit Risk is with the Client. Factor does not participate in the credit sanction process. In India, factoring is done with recourse.

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

Credit risk is with the Factor. Higher commission is charged. Factor participates in credit sanction process and approves credit
limit given by the Client to the Customer.

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

MATURITY FACTORING
Factor does not make any advance payment to the Client. Pays on guaranteed payment date or on collection of Receivables. Guaranteed payment date is usually fixed taking into account
previous collection experience of the Client.

Nominal Commission is charged. No risk to Factor.

CROSS - BORDER FACTORING

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

It is also called two-factor system of factoring. 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 and 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.

HSBC currently offers both domestic and international factoring products. Domestic Factoring
Through this product, HSBC intention is to be an active partner in the management of company's supply/delivery chain. Through domestic factoring, It could look at financing companys receivables from companys buyers. Additionally HSBC also undertake to finance companys vendor/supplier payments.

Contd..
Receivables Finance can be structured with on a With Recourse Basis (where HSBC would be setting up lines on company) or on a Without Recourse Basis. Payments of all company service and utility bills could be done through HSBCs Vendor Finance product. These could include for example, courier payments, electricity bills payments. Through this mechanism we will pay out your service provider on the due date of the invoice/bill and collect the money from you after a predetermined credit period.

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

DISCLOSED AND UNDISCLOSED FACTORING

Disclosed Factoring : The name of the factor is disclosed in their voice by the suppliers-manufacturer of the goods asking the buyer to make payment to the factor Generally ,the factors assumes the risk under non-recourse arrangements . Limit as non-recourse is laid down in agreement beyond which the dealings are done on a recourse base In undisclosed factoring, the client customers are not notified of the factoring arrangement The client himself undertakes sales ledger administration and collection of debts . Client has to pay the amount to the factor irrespective of whether customer has paid or not.

advantages
To the seller
Factoring provides a large and quick boost to cash flow. The client will be relieved of the work relating to sales
ledger administration and debt collection. production and sales.

The client can therefore concentrate more on planning Assists smoother cash flow and financial planning. Protected from bad debts ( non-recourse factoring)

Contd..
Credit sale are converted into cash. Client can offer competitive terms to his buyers &
improves his sales & ultimately profit.

With cash available for credit sales, client liquidity will

improve & therefore, production cycle will be accelerated.

On the contrary, a factor will provide classified periodical statement.

Client does not have to submit any periodical statements. Cash disbursals are instantaneous.

To the buyers
Customer get adequate credit period for payment of
assigned debts.

Customers save on high bank charges and expenses.

No documentation except acknowledgement of the

notification letter.

Factors furnish the customers with the periodical

statement of outstanding invoices factored on them.

Factoring does not impinge on their rights vis--vis the

supplier in respect of quality of goods, contractual obligations etc.

To the Banks
Factoring is not a threat to banking, it is a financial service complementary to that of the banks.

Factoring improves liquidity of banks borrowers.

Credit sales are closely monitored by the factor and

proceeds are routed through the clients accounts with the bank.

Factoring improves the quality of advances of banks.

To Exporters
Elimination of the cost and delays experienced in transacting
business under LC.

The import offers credit risk protection in case buyer does

not pay invoices with the 90 days of due date.

ECGC policy cost can be saved. There is reduction in

administrative cost as the exporter will be dealing with only one export factor irrespective of the number of countries involved.

The exporter can obtain valuable information on the standing

of the foreign buyers on trade customs and market potential in order to expand his business.

To Importers
He can pay invoices in the country locally.
He deals with the local agency, i.e. the import factor

Minimum documentation required.

The cost of letters of credit and delay on account of LCs
are eliminated. All communication is in his own language.

disadvantages
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.

FACTORING vs BILLS DISCOUNTING

1.
BILL DISCOUNTING Bill is separately examined and discounted.

1.

FACTORING Pre-payment made against all unpaid and not due invoices purchased by Factor.

2.

Financial Institution does not have responsibility of Sales Ledger Administration and collection of Debts. No notice of assignment provided to customers of the Client.

2.

Factor has responsibility of Sales Ledger Administration and collection of Debts.

3.

3.

Notice of assignment is provided to customers of the Client.

FACTORING vs BILLS DISCOUNTING

BILLS DISCOUNTING Bills discounting is usually done with recourse.

(contd)

4.

4.

FACTORING Factoring can be done without or without recourse to client. In India, it is done with recourse.

5.

Financial Institution can get the bills re-discounted before they mature for payment.

5.

Factor cannot re-discount the receivable purchased under advanced factoring arrangement.

FACTORING vs BILLS DISCOUNTING (contd)

BILL DISCOUNTING 6 Individual Transaction FACTORING 6 Whole turnover basis. This also gives the client the liberty to draw desired finance only. 7 A one time notification is taken from the customer at the commencement of the facility.

7 Each bill has to be individually accepted by the drawee which takes time. 8 Stamp duty is charged on certain usance bills together with bank charges. It proves very expensive.

8 No stamp duty is charged on the invoices. No charges other than the usual finance and service charge.

FACTORING vs BILLS DISCOUNTING (contd)

BILL DICOUNTING 9 More paperwork is involved. 10 Grace period for payment is usually 3 days. 11 . Original documents like MTR, RR, and Bill of Lading are to be submitted. 12 Charges are normally up front. FACTORING 9 No such paperwork is involved. 10 Grace periods are far more generous.

11 Only copies of such documents are necessary. 12 No upfront charges. Finance charges are levied on only the amount of money withdrawn.

FACTORING IN INDIA
1. 2. 3. 4. 5.
Canbank Factors Ltd. Banglore ECGC, Factoring Division, Mumbai Foremost Factors Ltd., New Delhi Global Trade Finance Ltd., Mumbai SBI Factors And Commercial Services Ltd., Mumbai 6. HSBC Factoring & Recievables Finance, Mumbai

WHY FACTORING HAS NOT BECOME POPULAR IN INDIA

Banks reluctance to provide factoring services Banks resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines).

Problems in recovery.
Factoring requires assignment of debt which attracts Stamp Duty. Cost of transaction becomes high.

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