10. factoring

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Factoring &

Forfaiting

What is Factoring?

FACTORING is a “continuing arrangement” between a financial institution (the factor) and a business concern (the client) selling goods or services to trade customers (the customer) whereby the factor purchases the client’s accounts receivables/book debts

What is Factoring?

Alternatively factoring is a collection and financial service where by receivables are purchased by the factor and credit sales are converted into cash sales

What is Factoring?

Factoring is a powerful financial instrument specially designed to meet the post sales working capital requirements of the Industrial, Trade & Service sectors

It is a portfolio of complementary financial services

What is Factoring?

Factoring is a financial option for the management of receivables

In simple definition, it is the conversion of credit sales into cash

In factoring, a financial institution (factor) buys the accounts receivable of a company (client) and pays up to 80% ( rarely up to 90%) of the bill amount

Collection of debt is done either by the factor or the client depending upon the type of factoring

Factoring Services

Besides purchase of accounts receivables, a factor may provide a wide range of services such as:

a) Sales Ledger administration b) Debt Collection services c) Credit Information services d) Advisory services

Loan Vs Factoring

The emphasis is on the value of the receivable ( essentially a financial asset), not the firm’s credit worthiness

Factoring is not a loan, it is the purchase of a financial asset ( the receivable)

A bank loan involves two parties whereas factoring involves three

Non-Recourse Factoring

It is the most comprehensive type of factoring arrangement offering all types of services namely:

Finance Sales Ledger Administration Collection Debt Protection Advisory Services

Non-Recourse Factoring

It gives protection against bad debts to the client

In other words, in case the customer fails to pay, the factor will have ‘no recourse’ to the client and will have to absorb the bad debts himself

It is popular in developed countries

Recourse Factoring

In this type of factoring arrangement, the factor provides all types of facilities except debt protection

In other words, the client is responsible for any bad debts incurred

It is popular in developing countries

Invoice Discounting

Invoice discounting is also a variant of factoring

Under this, a factor provides finance against invoices backed by LCs of Banks

This enhances client’s liquidity by converting credit sales into cash sales

Finance is provided once LC opening bank confirms due date of payment

Rate of discount (interest) and charges are very competitive and in accordance with the market trends

Advance & Maturity Factoring

In advance factoring, the factor pays a pre-specified portion of the factored receivables and the balance is paid on collection

In maturity factoring, payment is made only on the guaranteed payment date or on the date of collection

Old Line Factoring

Old line factoring is also known as full factoring as it provides an entire spectrum of services such as:

CollectionCredit protectionSales Ledger administrationShort term finance

It includes all features of non-recourse and advance factoring

Undisclosed Factoring

In undisclosed factoring, the client’s 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

Cross Border Factoring / International Factoring

In the international business transactions, factoring services are provided by factors of both countries

This is known as Cross Border Factoring / International Factoring

Factoring Mechanism

Client invoices his customer in the usual way-only adding a notification that the invoice is assigned to and must be paid to a FACTOR

Client submits copies of invoices to a FACTOR, accompanied by the receipted delivery challan or any other valid proof of dispatch

Factoring Mechanism

A FACTOR will provide pre-payment up to

80% of the invoice value Follows up with the customers for realization of payments due Balance payment made immediately on realization Sends monthly statement of account to keep the client informed of the factored invoices

Factoring Mechanism

Functions of a Factor

Instant Cash

Follow up and Speedy Collection

MIS Services

Sales Ledger Administration

Credit Protection

Advisory Services

Factoring Charges

Finance charge:

It is computed on the pre-payment outstandings in the account at monthly intervals

Service/Handling charge:

It is a nominal charge levied to cover the cost of services viz. collection, sales ledger management and periodical MIS reports. It ranges from 0.1% to 0.2% on the total value of invoices factored/ collected . The tax payable on Service/Handling charges is also recovered from clients

Benefits of Factoring (Client)

Credit sales are converted into cash Client will have substantial funds-up

to 80% of the factored invoices. It is much more than bank finance against credit sales. (Further increase is possible in exceptional cases.)

Client can offer competitive terms to his buyers and improve his sales and ultimately profit

With cash available for credit sales, client’s liquidity will improve and therefore, production cycle will be accelerated


Appraisal and documentation procedures are made simple and response time is very small

Cash disbursals are instantaneous Factoring provides much more than

bill discounting, like finance, collection, sales ledger administration, etc.

Client does not have to submit any periodical statements. On the contrary, a factor will provide classified periodical statement of outstanding invoices


Factoring replaces high cost market credit and enables purchases on cash basis availing cash discounts

The client is free from the tension of monitoring his sales ledger and can concentrate on production, marketing and other aspects

This results in a reduction in overhead expenses

The client can expand his business by exploring new market

Benefits of Factoring (Buyers)

Customers 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 periodical statement of outstanding invoices factored on them

Factoring does not impinge on their rights vis-a-vis the supplier in respect of quality of goods, contractual obligations, etc.

Benefits of Factoring (Banks)

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

Factoring improves liquidity of bank’s 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

International Factoring

Under Export Factoring, a factor in India factors export invoices drawn on overseas buyers and prepays the client an agreed percentage of the invoice value immediately

In international factoring, factoring services are provided by factors of both countries

The factor handling the collection of export receivables of clients (exporters) is called Export Factor (EF) and the factor in buyer’s country who undertake collection and credit protection services is called Import factor

International Factoring

In Export Factoring, the Export Factor appoints an Import Factor, who provides credit protection / exposure limits for a particular importer and only upon such approval the Export Factor provides financial assistance to the Indian Exporter

In view of this there is no requirement of a letter of credit or a credit insurance cover

Mechanism

The exporter ships the goods to importer. The exporter assigns his invoices through the

export factor to the import factor who assumes the credit risk. (as per prior arrangement).

The Export factor prepays invoices The importer pays the proceeds to the Import

factor, who transfers the amount to Export factor

The export factor deducts prepayment already made, other charges and pays the balance proceeds to the exporter

Benefits to Exporters Elimination of the cost and delays

experienced in transacting business under LC

The import factor offers credit risk protection in case buyer does not pay invoices with in 90 days of due date

ECGC policy cost can be saved. There is reduction is administrative cost as the exporter will be dealing with only one Export Factor irrespective of the number of countries involved.

Benefits to Exporters

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

The following up of receivables by import factor will speed up the collections

Usually, as factors provide finance up to 90% on export invoices, the exporter has an improved cash flow and his liquidity improves markedly

Benefits 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 LC’s are eliminated. All communication is in his own language.

Factoring in India

1. Canbank Factors Ltd. Bangalore

2. Export Credit Guarantee Corporation of India Ltd, Factoring Division,Mumbai

3. Foremost Factors Limited, New Delhi

4. Global Trade Finance Limited, Mumbai

5. SBI Factors and Commercial Services Pvt. Ltd. Mumbai

6. The Hongkong and Shanghai Banking Corporation Ltd. Factoring & Receivables Finance ,Mumbai

Factoring in India

Number of Factoring companies:

7

Domestic Factoring Turnover (in Millions of EUR):

4,715

International Factoring Turnover (in Millions of EUR):

340

Total Factoring Turnover (in Millions of EUR):

5,055

Forfaiting

The word forfaiting is derived from the French term “ a forfait ” which means “relinquishing a right”

Forfaiting is the discounting of international trade receivable on a 100% "without recourse" basis

It is a form of suppliers credit involving the sale or purchase of receivables falling due at some future date

Forfaiting

Traditionally, forfaiting is fixed interest rate and medium term (3-5 years) financing

Forfaiting is generally suitable for high value exports like heavy machinery, capital goods, consumer durable, vehicles, bulk commodities, consultancy and construction contracts and project exports

Forfaiting

Unlike factoring, forfeiters typically work with the exporter who sells capital goods, commodities, or large projects from 180 days to up to seven years

In forfeiting, receivables are normally guaranteed by the importer’s bank, allowing the exporter to take the transaction off the balance sheet to enhance its key financial ratios

Characteristics of Forfaiting

100% financing without recourse to the seller of the obligation

Importer's obligation is normally

supported by a local bank guarantee

The debt is typically evidenced by Letter of credit, Bills of Exchange, Promissory Notes

Credit periods can range from 90 days to 10 years

Characteristics of Forfaiting

Amounts financed to be upwards of USD 2,50,000/-

Contract in any of the world's major convertible currencies can be financed

Finance to be either on a fixed (market norm) or floating rate basis

Benefits

Enhances competitive advantage Ability to provide vendor financing

making products more attractive Enables the exporter to do business

in risky countries Increases cash flow. Forfaiting

converts a credit-based transaction in to a cash transaction

Benefits

Elimination of the following Risks associated with cross border transactions:

Commercial Risk - The risk of non-

payment by a non-sovereign or private sector buyer or borrower in his home currency arising from insolvency

Political Risk - The risk of the borrower country government actions, which prevent or delay the repayment of export credits

Benefits

Transfer Risk - The risk of an inability

to convert local currency into the currency in which debt is denominated

Interest Risk - The risk of interest rate

fluctuations during the credit period of the transaction

Exchange Risk - The risk of exchange

rate fluctuations

Factoring - Exercise

Turnover = Rs. 60 Lacs ( 80% on Credit) Debtors = 1 month to pay

Factoring Proposal:

Factor pays 90% of credit sales Factor fee : 2% p.m. Factor commission : 4% of total debts Likely savings of management cost: Rs

21,600 Avoidance of bad debt : 1% of credit

sales


Bank Proposal :

Advance of 90% of the debts Rate of interest : 18% p.a. Processing fee : 2% of debts


Fee 0.02 x 0.90 x Rs. 4,00,000

Rs. 7,200

Commission 0.04 x Rs. 4,00,000 Rs. 16,000

Sub-total Rs. 23,200

Less ; Saving in cost

Management costs

Rs. 21, 600 / 12 Rs. 1,800

Savings in bad debts

0.01 x Rs. 4,00,000 Rs. 4,000

Sub-total Rs. 5,800

Net Cost of factoring Rs. 17,400

COST OF FACTORING


Interest 0.18 x 1/12 x o.90 x Rs. 4,00,000

Rs. 5,400

Processing Fee

0.02 x Rs. 4,00,000 Rs. 8,000

Bad Debts 0.01 x Rs. 4,00,000 Rs. 4,000

Cost of bank advance Rs. 17,400

COST OF BANK ADVANCE

GOOD LUCK TO YOUGOOD LUCK TO YOU

10. factoring

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