Module Factoring

1. Module Factoring

2. Factoring • Meaning: • The selling of a firm’s accounts receivable to a third party , known as a factor is called factoring. • If a firm is not confident in its ability to collect on its credit sales, it may sell the right to receive payment to the factor at a discount. • The factor then assumes the credit risk associated with the accounts receivable. • This allows the firm access to working capital immediately , which is important especially if the firm might otherwise have a cash flow problem. • The price of accounts receivable financing is determined by the credit worthiness of the firm’s customer , not the firm itself.

3. Definition: • “Factoring is a method of financing whereby a company sells its trade debt at a discount to financial institution. • Factoring is a continuous arrangement between a financial institution (factor) and a company (namely the client) which sells goods and services to trade customers on credit.”

4. Modus Operandi of Factoring: • There should be a factoring arrangement – Invoice purchase arrangement – between client (Business concern) and the factor (Financing organization). • When ever the client sells goods to trade customers on credit he prepares invoice – without raising bill of exchange • The debt due by the purchaser to the client is assigned to the factor by advising the trade customers, to pay the amount due to the client, to the factor • The client hands over the invoices to the factor under the cover of a schedule of offer along with the copies of invoices and receipted delivery challans or copies of R/R or L/R • The factor makes an immediate payment upto 80% of the assigned invoices and balance 20% will be paid on realisation of the debt.

5. Functions of Factor: • Purchase and collection of debts • Sales ledger maintenance • Credit investigation and undertaking of credit risk • Provision of finance against debt • Rendering consultancy services

6. Types of Factoring: • 1.Full Service Factoring or Without Recourse factoring: • Here a factor • provides finance, • administers the sales ledger, • collects the debts at his risk and renders consultancy service. • If the debtors fail to repay the debts, the entire responsibility falls on the shoulders of the factor since he assumes the credit risk also. • He cannot pass this responsibility to his client and hence this type of Factoring is also called as Without Recourse factoring

7. With Recourse Factoring: • Under this type , the factor does not assume the credit risk. • If the debtors do not repay their dues in time & if their debts are outstanding beyond a fixed period, say 60 to 90 Days from the due date are automatically assigned back to the client • The client has to take up the work of collection of overdue account by himself. • If the client wants the factor to go with the collection work of overdue accounts the client has to pay extra charges called “ REFACTORING CHARGES”

8. Maturity Factoring/ collection factoring • Here, the factor does not provide immediate cash payment to the client at the time of assignment of debts. • He undertakes to pay cash as & when collections are madefrom the debtors. • The entire amount collected less factoring fees is paid to the client immediately. Hence, it is also called “Collection Factoring” . • Here no financing is involved. But all other services are available

9. Invoice Factoring: • Here , the factor simply provides finance against invoices without undertaking any other functions . • Invoice your customer as normal • Send Factor a copy too and they will advance you up to 90% of the invoice value • You continue to chase payment of the invoice • Once your customer pays, factor send you the remaining amount minus fees • All works connected with sales administration, collection of dues etc. Have to be done by the client himself.

10. The debtors are not at all notified & hence they are not aware of the financing arrangement. • This type of factoring is confidential in nature and hence it is called as Confidential Invoice discounting or undisclosed factoring  • Agency Factoring: • Here, the factor & the client share the work between themselves as follows : • The client has to look after the sales ledger administration & collection work • The factor has to provide finance & assume the credit risk

11. Bulk Factoring: • This is otherwise called as “Disclosed Factoring” or “Notified Factoring” • Here the factor provides finance after disclosing the fact of assignment of debts to the debtors concerned. • This type of factoring is resorted to when the factor is not fully satisfied with the financial condition of the client. • The work relating to sales ledger administration, Credit Control, Collection work etc., has to be done by the client himself. • Since the notification has been made, the factor simply collects the debts on behalf of the client.

12. Supplier Guarantee Factoring: • It is suitable for business establishment which sell goods through middlemen. • Generally goods are sold through wholesaler, retailer or through middleman • In such cases, the factor guarantees the supplier of the goods against invoices raised by the supplier upon another supplier. • The bills are assigned in favour of the factor whom guarantees payment of those bills. • This enables the supplier to earn profits without much financial involvement

13. Limited Factoring: • Here, the factor does not take up all the invoices of a client. • He discounts only selected invoices on merit basis & converts credit bills into cash in respect of those bills only . • Buyer Based factoring: • under this type, the buyer approaches a factor to discount his bills. Thus the initiative for factoring comes from the buyer’s end. The approved buyers of a company approach a factor for discounting their bills to the company in question. • In such a case, the claims on such buyers are paid by discounting the bills without recourse to the seller & the seller also gets ready cash. • This facility is available only reputed credit worthy buyers & hence it is called “Selected BUYER BASED FACTORING”

14. Seller Based Factoring: Here, the seller, instead of discounting his bills, sells all his accounts receivables to the factor, after invoicing the customers. The sellers job is over as soon as he prepares the invoices. Thereafter, all the documents connected with the sale are handle over to the factor who takes over the remaining function. This facility is extended to reputed & credit worthy sellers & hence it is also called “Selected Seller Based Factoring”

15. Difference Between Factoring and Bills Discounting

18. Benefits of factoring: • Financial service • Collection service • Credit risk • Provision of expertise sales ledger management service • Consultancy service • Off balance sheet financing • Economy in servicing

19. Export Factoring: • When the claims of an exporter are assigned to a banker or any financial institution – and the financial assistance are obtained on the strength of export documents and the guarantee payments , it is called export factoring • Factor/ Bank are located in the country of the exporter. • Factor/ Bank admits a usual advance of 50 to 75 percent of the export claim as advance. • Export factoring is offered both as a recourse and as a non recourse factoring

20. Forfaiting: Definition: Forfaiting is the sale by an exporter of export trade receivables, usually bank guaranteed, without recourse to the exporter. Such receivables include Letters of Credit (with or without Bills of Exchange) Promissory Notes with Aval (guarantee), Bill of Exchange with Aval, Bank Guarantees Payable to an Exporter in one country from an Importer in another country. Meaning: Forfaiting is a method of trade finance that allows exporters to obtain cash by selling their medium and long-term foreign accounts receivable at a discount on a “without recourse” basis

21. Mechanism: Step 1: The exporter approaches a forfaiter before finalizing the transaction’s structurewith the importer. Step 2: Once the forfaiter commits to the deal and sets the discount rate, the exporter can incorporate the discount into the selling price. Step 3: The exporter then accepts a commitment issued by the forfaiter, signs the contract with the importer, and obtains, if required, a guarantee from the importer’s bank that provides the documents required to complete the forfaiting.

22. Step 4: The exporter delivers the goods to the importer and delivers the documents to the forfaiter who verifies them and pays for them as agreed in the commitment. Since this payment is without recourse, the exporter has no further interest in the financial aspects of the transaction and it is the forfaiter who must collect the future payments due from the importer.

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24. Difference between Export factoring and Forfaiting Factoring Forfaiting For transaction with medium term maturity period Can be without recourse only All risk are assumed by the forfaiter Suitability: For transactions with short term maturity period Recourse: Can be either with or without recourse Risk: Risk can be transferred to seller

25. Factoring Forfaiting Cost of forfaiting is borne by the overseas buyer (importer) Hundred percent finance is available Financing depends on the financial standing of the guarantee banking Cost: Cost of factoring is usually borne by the seller Extent of financing: Only a recent percent of receivables factored is advance Basis of financing: Financing depends on the credit standing of the exporter

26. Factoring Forfaiting It is pure financing Services: Besides financing, a factor also provides other services such as ledger, administration etc