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Factoring andForfaiting

Chapter 6

Financial Services

M Y Khan


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Factoring - Meaning

Is a financial service

Institution called Factor which -

Undertakes the task of realizing receivables,i.e. accounts receivables, book debts, billsreceivables &

Also the Factor manages the sales registers,

sundry debts of the commercial firms/tradingagents , for a commission.

This activity is called Factoring


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Factoring - definition

C.S. Kalyansundaram a continuingarrangement under which a financing institutionassumes the credit and collection functions for itsclient, purchases receivables as they arise,

maintains the sales ledger, attends to other bookkeeping duties relating to such accounts andperforms other auxiliary functions.

Can also be broadly defined as an agreement inwhich receivables arising out of sale ofgoods/services, are sold by a firm, to the Factor ,as a result of which the title to the goods/servicespasses on to the Factor.


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Mechanism

Seller does not maintain a collection/credit department.

After sale, a copy of the invoice, delivery challan, theagreement, other papers are handed over to the Factor.

The Factor receives payment from the buyer on the due

date as agreed, whereby the buyer is reminded of the duedate payment amt. for collection.

The Factor remits the money collected to the seller afterdeducting its own service charges at the agreed rate.

Thereafter the seller closes all transactions with the

Factor. The seller passes on papers to the Factor for recovery of

the amount.


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Mechanism..

Merchant Customer

Factor

Credit Transaction (1)

Agreement (2)

FactorFinancing (5)

Handing over Inovice(4)

Factoring Contract for sale of receivables.(3)

ReceivingPayment(6)


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Characteristics

The Nature

Similar to bailment contract. Specialized activitywhere Factor assumes the risk associated withcollection of receivables.

If the debtor does not pay the Factor bears the riskof bad debt loss.

The Form

Takes the form of Invoice Factoring, as covers

receivables not covered under NI Act. Factoring of receivables helps the firm do away with

the credit department, and its debtors become thedebtors of the Factor.


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Characteristics

The Assignment

Assignment of debt in favour of the factor. This is a basicrequirement for the working of a factoring service.

Fiduciary Position

Position of the factor is fiduciary in nature, as it arises from therelationship with the client firm. The Factor is mainly responsiblefor fulfilling the terms of the contract between the parties.

Professionalism

Factoring firms professionally competent, with skilled persons to

handle credit sales realizations for different clients in differenttrades, for better credit management.


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Characteristics

Credit Realizations

Help in avoiding the risk of bad debt loss, whichmight arise otherwise.

Less Dependence.

Factor reduces the dependence on banks forworking capital finance. This relieves the firm greatlyof the burden of finding funding facility.

Recourse Factoring

Non Recoursethe Factor will have no recourse tothe seller on non payment from the customer. WithRecourse The factor will have recourse to theseller in the event of non payment by the buyers.


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Characteristics.

Compensation

A Factor works in return for a service charge

calculated on the turnover. Factor pays the

net amount after deducting the necessary

charges, some of which may be special terms

to handle the accounts of certain customers.


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Types of Factoring

Domestic Factoring

Export Factoring

Cross Border Factoring

Domestic Factoring

- Factoring that arises from transactions relating todomestic sales is known as Domestic Factoring.

Three Types : Disclosed Factoring, Undisclosed

Factoring, Discount Factoring.


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Domestic Factoring

Disclosed Factoring : Name of proposed Factor mentioned on the invoice,

made by the seller of goods.

Buyer to pay directly to the Factor.

Could be recourse or non Recourse.

Undisclosed Factoring :

Name of the proposed Factor not disclosed by the seller

in the invoice. But all sales realization done by the Factor in the name

of the seller.

Control of all the monies with the Factor.

Quite popular in the U.K.


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Domestic Factoring..

Discount Factoring :

Is a process where the Factor discounts the

Invoices of the seller at a pre-agreed credit

limit with a financing institution.

Book debts and receivables serve as

securities for obtaining financing

accommodation.


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Export Factoring

Where the claims of an exporter are assigned to abank/financial institution, and the exporter obtains

finance on the strength of export documents and

guaranteed payments, it is Export Factoring

The Factor bank is in the country of the exporter. Itadmits upto 50-75%, advance on the export claims.

If importer does not honor claims, the exporter has

to make the payment to the Factor.

Export Factoring offered as both Recourse and NonRecourse factoring.


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Cross Border Factoring

It involves the claims of an exporter assigned to a

bank/financial institution in the importers country, on the

strength of the export documents and guaranteed

payments.

International factoring always works on Non recoursefactoring model. They handle the overseas credit sales

of the exporter. Complete protection to the exportersagainst bad debts loss on credit approved sales.

Factors take assistance and avail the facilities providedby the exporting country.

For the exporter, once the goods are shipped , hissole debtor is the Factor.


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Cross border Factoring...

Methods of dealing:

Export factor : exporter informs the the export factorabout the export of goods, to an import client, regarding

goods sold on credit. Import Factor : export factor writes to the import factor

enquiring about the credit worthiness , reputation of the

importer.

Delivery : exporter delivers the goods to the importer.Then he delivers the relevant documents(invoices, bill of

lading, other supporting documents) to the export factor.


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Cross border Factoring... Methods of dealing: Credit Information: the export factor works with the

import factor , for credit checking, sales ledgering &

collection in importers country.

The import factor disseminates credit information aboutimporter, and on maturity of credit period, makes

payment to the export factor, on assignment of

documents .

Payment:the export factor makes the payment to theexporter upon assignment/collection of export

receivables, depending upon the type of factoring

arrangement between them.


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Full Service Factor

Also known as Old Line Factoring

Factor has no recourse to the seller, in case ofdefault by buyer.

With Recourse Factoring:- Factor has recourse to the client firm for

irrecoverable book debts.

- Factor entitled to recover dues from advance

payment if customer defaults.- They charge the client for maintenance of sales

ledger, collecting customers debt etc.


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Without Recourse factoring

Factor does not have recourse to the client

(seller) in case of default.

Factor bears the loss of irrecoverable debts.

For which they charge Del CredereCommission as compensation for the

loss.

Factor actively involves in the process ofgrant of credit to customers.


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Advance & Maturity Factoring

Advance payment by the Factor in the rage of

70-80% of receivables factored. Balance on

payment by the customers.

Factor collects interest on the same.

This ROI on basis of Prevailing Short term

rate, Financial Standing of the Client etc.


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Bank Participation Factoring

Variation of Advance and Maturity Factoring

The Factor arranges part of the advance

payment through a banker.

Net Factor advance calculated as:

{Factor Advance Percent X Bank Advance

Percent}


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Collection /Maturing Factoring

No advance payment by the Factor.

Payment by the Factor on the Guaranteed

date or Date of collection.

Guaranteed date fixed after considering the

previous ledger experience of the client , and

date of collection being reckoned after due

date of the invoice.


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Advantages of Factoring

Cost Savings

Leverage

Enhanced Return

Liquidity

Credit Discipline

Credit Certification

Information Flow Prompt Payment

Infrastructure

Boon to SSI sector

Efficient Production

Reduced Risk


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Functions of the Factor

Sales Ledger Maintenance

Collection of accounts receivables

Financing facility for trade debts Assumption of credit risk/credit control and

credit protection

Provision of advisory services


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INDIAN FACTORING

Features :

Domestic Factoring

With recourse

undertakes collection & credit services Advance upto 80% of receivables

maintenance of sales ledger, with monthly sales and

invoice overdue analysis.

Factors provide payment reports to the clients.

Factors charge by way of service charges/fee without

guarantee being insisted upon.


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INDIAN FACTORING ...

Export Factoring:

ECGC has been approved by RBI to provide

non fund based export factoring service.

ECGC grants 100% credit protection to bills

drawn on approved overseas buyers through

endorsement to the policy.

ECGC enters into a tripartite agreement with

the exporter and the authorized dealer .


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INDIAN FACTORING..

OPERATIONAL PROBLEMS

Lack of access to common source of information.

Lack of experience and database to take on jobs such as

credit evaluation of clients. Expensive system of multiple databases maintained by

Individual factors.

Lack of uniformity in the specialized credit information

agencies. High stamp duty on assignment of debt to Factors.

High cost of operations and resulting less profitability for

the factors.


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FORFAITING

A form of financing of receivables arising from

international trade is knows as Forfaiting.

Bank/financial Inst. Purchases the trade

bills/promissory notes without recourse to the seller. Purchase through discounting of the documents .

Entire risk of non payment at the time of selection,

covered.

All risks become the full responsibility of theforfaiter(purchaser). Forfaiter pays cash on

discounting the bills/notes, to the seller.


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FORFAITING...

Characteristics :

Essentially involves non recourse bills discounting.

Bills of Exchange/promissory notes accepted by

importer, co-accepted by the bank in favour offorfaiting agency , are exchanged for discounted

cash proceeds.

Discount rates are charged as a % above Euro

Market Interest Rates.

A forfaiter may buy or sell these bills like any other

security, in the secondary market.


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Forfaiting...

Steps

Commercial contract signing:

between exporter and importer , including basic

terms such as cost of forfaiting, margin to cover risk,days of grace, fee to compensate the forfaiter for

loss of interest due to payment delays, etc.

Transaction

Exporter sells and delivers the goods to the

importer.


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Forfaiting...

Notes Acceptance

The importer accepts a series of bills /promissory

notes in favour of the exporter for payment including

interest charges. The accepted notes sent to the exporter ,with bank

guarantee in respect of the promissory notes/bills.

Factoring Contract

Exporter and forfaiting agent enter into a forfaiting

contract .The forfaiter, is usually a reputed bank,

including the exporters bank.


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Forfaiting...

Sale of notes

The exporter sells the notes/bills to the

forfaiter(bank) at a discount without recourse.

Payment

the forfaiter makes payment to the exporter

for the face value of the bill/note , less

discount charges .The forfaiter may either

hold these bills/notes, or sell them in the

secondary market .


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Forfaiting in India

Permitted since 1992

essentially a method of post shipment export

finance.

Here also it is non recourse finance, which

converts credit sale into cash sale.

Does not lock up any bank limits.

Considered valuable medium to long term

post shipment finance for large size exports.

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