FACTORING

DEFINITION

Factoring is a financial transaction whereby a business sells itsaccounts receivable (i.e., invoices) to a third party (called afactor) at a discount in exchange for immediate money withwhich to finance continued business.

FACTORING VS BANK LOAN

Factoring differs from a bank loan in three main ways.

First, the emphasis is on the value of the receivables (essentially afinancial asset), not the firm’s credit worthiness.

Secondly, factoring is not a loan – it is the purchase of a financialasset (the receivable).

Finally, a bank loan involves two parties whereas factoring involvesthree.

FUNCTIONS OF FACTORINGCredit Evaluation: Assessment of credit-worthiness of customer

Sales Ledger Administration: Recording, analysing, and reportingsales transactions

Collect Book Debts: Collection of accounts receivables fromcustomers as & when they become due

Assume Risk of Default: Collection of receivables from customers,relieving the client-firm of credit risk or bad debt losses.

FUNCTIONS OF THE FACTORINGProvide Finance: Providing finance to client-firm against bookdebts, upto 90% of invoice value of the factored receivables

Provide Information: Advisory services on marketing strategies andforeign collaborations, sales analysis, invoice analysis, etc

Provide Insurance: Debt Insurance to client-firm against possiblelosses due to bankruptcy or insolvency

ADVANTAGES1. It helps to improve the current ratio. Improvement in thecurrent ratio is an indication of improved liquidity. Enables betterworking capital management.

2. It increases the turnover of stocks.

3. It ensures prompt payment and reduction in debt.

4. It helps to reduce the risk. Present risk in bills financing likefinance against accommodation bills can be reduced to minimum.

5. It helps to avoid collection department. The client need notundertake any responsibility of collecting the dues from thebuyers of the goods.

LIMITATIONS1. Factoring is a high risk area, and it may result in overdependence on factoring, mismanagement, over trading of evendishonesty on behalf of the clients.

2. It is uneconomical for small companies with less turnover.

3. The factoring is not suitable to the company’s manufacturing andselling highly specialized items because the factor may not havesufficient expertise to assess the credit risk.

4. The developing countries such as India are not able to be wellverse in factoring. The reason is lack of professionalism, non-acceptance of change and developed expertise.

PROCESS OF FACTORING

Step I. The customer

places an order with

the seller (the

client).

Step II. The factor and the seller

enter into a factoring agreement

about the various terms of

factoring.

Step III. Sale contract is entered

into with the buyer and the

goods are delivered. The invoice

with the notice to pay the factor

is sent along with.

Step IV. The copy of invoice

covering the above sale is sent to

the factors, who maintain the

sales ledger.

Step V. The factor prepays 80%

of the invoice value.

Step VI. Monthly Statements are

sent by the factor to the buyer.

Step VII. If there are any unpaid

invoices follow up action is

initiated.

Step VIII. The buyer settles the

invoices on expiry of credit

period allowed.

Step IX. The balance 20% less the

cost of factoring is paid by the

factor to the client.

TYPES OF FACTORING

Recourse factoring

Non-recourse factoring

Advance factoring

Maturity factoring

Invoice factoring

Supplier guarantee factoring

Bank participation factoring

Cross-border factoring

Confidential & undisclosed factoring

RECOURSE & NON-RECOURSE FACTORING

Recourse Factoring: In Recourse factoring, the credit riskremains with the client though the debt is assigned to thefactor, i.e., the factor can have recourse to the client in theevent of non-payment by the customer.

Non-Recourse Factoring: The Non-Recourse Factoring, alsocalled as ‘Old-line factoring’, is an arrangement whereby hefactor has no recourse to the client when the bill remainsunpaid by the customer. Thus, the risk of bad debt isabsorbed by the factor.

MATURITY & ADVANCE FACTORING

Maturity Factoring: In maturity factoring method, thefactor may agree to pay an amount to the client for thebills purchased by him either immediately or on maturity.The later refers to a date agreed upon on which the factorpays the client.

Advance Factoring: Where the payment is made by thefactor immediately is called Advance Factoring Under thistype of factoring, the factor provides financialaccommodation apart from non-financial servicesrendered by him.

INVOICE FACTORING

It is simply a bill discounting process.Invoice discounting is a form of short-term borrowing oftenused to improve a company's working capital and cash flowposition.Invoice discounting allows a business to draw money againstits sales invoices before the customer has actually paid. To dothis, the business borrows a percentage of the value of itssales ledger from a finance company, effectively using theunpaid sales invoices as collateral for the borrowing.

CONFIDENTIAL AND UNDISCLOSED FACTORING

In confidential and undisclosed factoring the arrangementbetween the factor and the client are left un-notified to thecustomers and the client collects the bills from the customerswithout intimating them to the factoring arrangements.

SUPPLIER GUARANTEE FACTORING

Supplier Guarantee Factoring is also known as ‘drop shipmentfactoring’. This happens when the client is a mediator betweensupplier and customer. When the client is a distributor, thefactor guarantees the supplier against the invoices raised bythe supplier upon the client and the goods may be delivered tothe customer. The client thereafter raises bills on the customerand assigns them to the factor. The factor thus enables theclient to make a gross profit with no financial involvement atall.

BANK PARTICIPATION & CROSS-BORDER/INTERNATIONAL FACTORING

Bank Participation Factoring: In bank participation factoring thebank takes a floating charge on the client’s equity i.e., theamount payable by the factor to the client in .respect of hisreceivables. On this basis, the bank lends to the client andenables him to have double financing.

Cross-border/International Factoring: In domestic factoring,there are 3 parties involved – customer, client and factor. But ininternational factoring, 4 parties are involved, namely –exporter(client), importer(customer), export factor, and importfactor.

FINANCIAL ASPECTS

FACTORING

&

BALANCE

SHEET

FACTORING & BALANCE SHEET

Impact of Factoring on Balance Sheet:

Reduction of Current Liabilities.

Improvement in Current Ratio and Efficiency.

Higher credit standing.

Reduction of cost and expenses.

FACTORING AND P&L ACCOUNTThe Benefits of factoring in terms of the profit and loss accountare analyzed as under:

The factor performs basis functions like administration ofseller’s sales ledger, credit control, collection of dues, etc. Thissaves the administration costs.

The improved liquidity position enables the firm to honour itsobligations without any delay.

The improved credit standing helps the firm to get the benefitsof lower purchase price, longer credit period from suppliers,trade discount on bulk purchases, cash discount on earlypayment, better market standing, quicker sanction of loans andadvances, and better terms and conditions while borrowing etc.

FACTORING CHARGES

Finance Charge: Finance charge is computed on the prepaymentoutstanding in the client’s account at monthly intervals. Financecharges are only for financing that has been availed. Thesecharges are similar to the interest levied on the cash creditfacilities in a bank.

Service fee: Service charge is a nominal charge levied at monthlyintervals to cover the cost of services, namely, collection, salesledger management, and periodical MIS reports. Service fee isdetermined on the basis of criteria such as the gross sales value,number of customers, the number of invoices and credit notes,and the degree of credit risk represented by the customers orthe transaction.

PROSPECTS OF FACTORING IN INDIA

THE KALYANASUNDARAMREPORT

In 1988, RBI formed a committee headed by CS Kalyansundaram,a former managing director of the State Bank of India SBI toexamine the need for and the scope of factoring organizations inIndia. The committee submitted its report in December 1988 andrecommended introduction of factoring services in India. The RBIadvised banks to take up factoring activity through a subsidiary.

NEED FOR FACTORING SERVICES IN INDIA

There is sufficient scope for the introduction of factoringservices in India, which would be complementary to the servicesprovided by banks.

The introduction of export factoring services in India wouldprovide an additional facility to exporters.

With a view to attaining a balanced dispersal of risks, factorsshould offer their services to all industries and all sectors of theeconomy.

RBI GUIDELINES

Banks are permitted to set up separate subsidiaries/invest infactoring companies.

Should not engage in financing of other companies or otherfactoring companies.

Investment of a bank cannot exceed in the aggregate 10% of paid-up capital and reserves of the bank.

According to the RBI guidelines (2010), banks now with the priorapproval of RBI can form subsidiary companies for undertaking thefactoring services and other incidental activities.

SBI FACTORS AND COMMERCIAL SERVICES

The State Bank of India, in association with the State Bank ofIndore, the State Bank of Saurashtra, SIDBI, and the Union Bankof India set up the SBI Factors and Commercial Services inFebruary 1991.

SBI Factors commenced operations from April 1991. SBI factorswas the first factoring company to be set up in India. It has a45% market share in this business. SBI Factors offers domestic,export, and import factoring services.

SBI FACTORS AND COMMERCIAL SERVICES

SBI factors offers two types of products under domesticfactoring:

Bill2Cash: - The seller invoices the goods to the buyer, assignsthe same to SBI factors, and receives prepayment up to 90percent of the invoice values immediately.

Cash4Purchase: Facilitates instant payment for purchases madeand is generally sanctioned in conjunction with receivablefactoring facility or export factoring.

CANBANK FACTORS LTD.

Jointly promoted by the Canara Bank, Andhra Bank and SIDBI inAugust,1992.

Its Rs. 10 crore paid-up capital was contributed in theproportion of 60:20:20 by three promoters respectively.

Initially operated in the south zone but regional restrictions ontheir operations were subsequently removed by the RBI.

Main services provided by the Canbank Factors Ltd aredomestic factoring and invoice discounting.

REASONS FOR SLOW GROWTH

The overall worldwide growth in factoring is estimated at 12%.Europe has the largest market representing 64% of the worldvolumes with a growth of 18% during the year. America'sgrowth was 10%, whereas Australia recorded impressive growthof 40%. Asia saw a fall in volume.

The growth trends mentioned above support the fact that thereis enormous scope for expansion worldwide and India is noexception to this.

The potential in India is estimated at an annual turnover of Rs.15000 to Rs. 20000 crore, but large portion is untapped.

REASONS FOR SLOW GROWTHLack of a credit appraisal system and authentic information aboutcustomers and clients restricts the growth of this business.

Higher stamp duty on assigning of debt increases the cost of theclient which reduces factoring arrangements.

Non availability of permission to factoring companies for raisingtheir debt restricts their financing capacity and thereby growth ofthe market.

Being registered as NBFCs, factoring companies are not eligiblefor refinance which limits the extension of this facility to theexporters on open account sales. This restricts the growth of themarket.

THANK YOU

SUBMITTED BY:

KUSHAL WALIA UM 10905

PUJIT SINGH UM 10304

SHIVAM MIGLANI UM 10307

SAHIB SINGH UM 10809