Factoring & Forfeiting

What is Factoring?Factoring is a financial transaction in which a business sells its accounts receivable (i.e, invoices) to a  factor at a discount.

* It is the conversion of credit sales into cash.

* a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80%(rarely up to 90%) of the amount immediately on agreement.

* Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when the customer pays the debt. Collection of debt from the customer is done either by the factor or client

Case Study #1... James Manufacturing, Inc.

James Manufacturing is a small builder of boat trailers and related products.

Bill James, its owner, was awarded a contract to supply the Florida Fish and Wildlife Conservation Commission with 72 new trailers to replace old units that were rusty and failing.

Each trailer was $2,900 for a total value of $208,800.

James had 20 trailers in inventory to begin delivery and the contract called for all trailers to be delivered within 60 days.

Problems Faced By James:-

•It had little excess capital.

•The state pays slowly and Bill James knew he would not

receive payment for the 20 trailer.

•He needed cash to order bulk steel and hardware to build the

remaining 52 trailers and to be able to deliver them by the 60 day

purchase order deadline

Solution:-

•He visited a local community bank where the loan officer explained

him the need of factoring.

•James was introduced to bank’s factoring officer.

•An account was immediately established to provide working capital to

meet the order.

.

RESULT

• Through factoring, James would receive an initial advance

from the bank of $46,400 (80%) on the $58,000 invoice after

delivery of the 20 finished trailers in inventory.

• That advance of $46,500 was enough to then buy the bulk

steel and hardware to complete the other 52 trailers in time.

• After the state paid for the 20 trailer shipment, the bank

would then give James the $11,500 not initially advanced

less a small factoring fee for services.

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The factoring arrangement was exactly what James needed to take his small company to the next level. It speed up the company's cash flows.There were no requirements for lengthy lending committee meetings to approve the credit line increase

CASE STUDYBETTY’S BUILDING SERVICE,INC

BETTY'S BUILDING MAINTENANCE SERVICE, INC. PROVIDES EXTERIOR BUILDING MAINTENANCE INCLUDING PRESSURE WASHING AND WINDOW CLEANING

Betty receives many opportunities in the past as the contracts are

relatively large and both the county and city take 45 days to make

payment for services performed.

Betty's company has few hard assets to be used as collateral and

she cannot secure any form of business loan

Betty was contacted by Bill, a loan broker and small business

consultant, who explained to her the benefits of factoring

Bill then introduced Betty to a factor's business development

officer who quickly forwarded a proposal for a factoring

arrangement whereby Betty would be charged a flat rate of 4% of

the invoice face amount for the first 45 days the invoice was

outstanding and 1% for each fifteen days thereafter.

Betty's profit margin of 25% easily absorbed the factor's fee and

left her with a 20% or greater profit margin.

Betty executed her factoring agreements and established her

client relationship with the factor. She was awarded a $25,000

monthly contract to provide maintenance on five local county

buildings. She also won the bid for maintenance on the City Hall

for over $100,000 per year.

This makes factoring a perfect

Working capital solution for

new startups and companies in

their early stage of business

development that have not

yet developed a credit history.

Came into existence in the year 1920

It was not an organised sector that time

Association of British Factors(ABF) came in 1976

Nearly 90% of global factoring turnover comes from USA &

European countries

RBI appointed the C.S.Kalyanasundaram Committee (1988)

It suggested to start factoring by a bank through its

subsidiary

ORIGIN

Worldwide, factoring volume is more than USD 700 billion a

year

Spread over nearly 60 countries and covering more than

1,00,000 businesses.

Particularly in developed countries, factoring is an accepted

way of conducting business.

AS OF TODAY,

FCI is a global network of leading factoring countries

It helps its members achieving competitive advantage through:

A global network

Modern & effective communication system

Reliable legal framework

Standard procedures

Universal quality

World wide promotion

Training programmes

FCI (FACTORS CHAIN INTERNATIONAL)

Can Bank Factors Ltd. - Bangalore www.canbankfactors.com

CitiBank – Mumbai

ECGC of India Ltd.- Mumbai

Foremost Factors Ltd.- New Delhi www.foremostfactors.net

Global Trade Finance Ltd.- Mumbai www.gtfindia.com

SBI Factors & Commercial Services Pvt.Ltd – Mumbai

www.sbifactors.com

The HSBC Ltd. - Mumbai www.hsbc.co.in

FCI MEMBERS

(Rs. crores)

Current Liabilities (CL) Current Assets (CA)

Bank borrowing against Inventory 100

i. Inventory 70 Receivables 80

ii. Receivables 50 Other current assets 20

120

Other current liabilities 30

150

Net Working Capital (CA-CL) 50

Total Current Liabilities 200 Total Current Assets 200

Original Current Ratio 1:33: 1 (200 : 150)

OFFSHEET

BALANCE SHEET: POST-FACTORING POSITION

(Rs. crores)

Current Liabilities (CL) Current Assets (CA)

Bank borrowing against Inventory 100

i. Inventory 70 Recievables(due frm factor) 16

Other current Liabilities 16 Other current assets 20

86

Net Working Capital (CA-CL) 50

Total Current Liabilities 136 Total Current Assets 136

New Current Ratio 1.581: r-(136 : 86)

IMPACT OF FACTORING ON BALANCE SHEET

Improvement in Current Ratio.

The current ratio improves from 1.33: 1 (before factoring) to

1.58 : 1. The new current ratio is better for the client and his

credit rating goes up before public eye.

Reduction in Current Liabilities.

An advance payment of Rs. 64 crores (i.e. 80% of 80 crore)

is utilised in repaying the bank borrowings against

receivables to the tune of Rs. 50 crores and for meeting

other current liabilities to the tune of Rs. 14 crores.

An exporter recently approached AIB Trade Finance Services with a common problem. The company was spending a lot of time chasing their debtors for payment. The Financial Director complained that despite having delivered their goods to the buyer, they were incurring considerable expense in staff time and communication costs in order to chase their money.Despite the buyer's agreement to pay at the end of the month following the invoice date, the exporter found that payment was actually received 30 to 60 days later. In addition the time spent chasing the payment was creating additional costs as well as increasing the time spent.

CAN THE EXPORTER REGAIN CONTROL?AIB Trade Finance Services advised the company to consider using a Documentary Collection to obtain payment, or a commitment to pay from the buyer. This meant the exporter was encouraged to send their shipping documents to the buyer through the banking system accompanied by a Bill of Exchange* drawn on the buyer with a payment date at the end of the month following the date of shipment.The exporter instructed AIB Trade Finance Services, who in turn instructed the buyer's bank, to only release the shipping documents to the buyer against their acceptance of the Bill of Exchange and their agreement to make the payment on the due date. In addition AIB Trade Finance Services was able to instruct the buyer's bank to hold the accepted Bill of Exchange and present it to the buyer for payment on the due date.

CASE STUDY

THE BENEFITS FOR EXPORTERS WHEN USING DOCUMENTARY COLLECTIONS.The use of a Documentary Collection gives an exporter greater control over their goods and when they get paid.•The exporter can use the banking system to obtain the buyers commitment to pay.•The exporter can also use the banking system to collect the debt.•The exporter can retain control over their shipping documents until the buyer has paid or agreed to pay.•Documentary Collections are a relatively inexpensive payment mechanism.For further protection and control the exporter could have requested that the buyer's bank guarantee the buyer's commitment to pay. This provides additional benefits as follows:•Gives greater security as the buyer's bank has added its guarantee that the Bill of Exchange will be paid at maturity.•It eliminates the risk of non-payment in the event of the buyer having difficulties.•It also provides an opportunity to obtain finance through non-recourse Bill discounting.

CONCLUSION This is an acceptable trading option for well known and financially secure customers in developed economies, it may not be appropriate for customers with weaker financial positions or located in less developed economies. The Documentary Collection can provide some additional security for the exporter whilst ensuring that the payment process is not unduly expensive or complex.

INVOICE DISCOUNTING CASE STUDY-DEMICA

Close Invoice Finance Limited started life as a small factoring company called Century Factors, based above a car showroom in Yeovil, Somerset. Century became one of the first acquisitions by Close Brothers and in 1993 its name was changed to Close Invoice Finance Limited.When the company started in 1984, it had just 20 clients. Today it provides finance services to over 1,000 clients and has won many accolades. Close Invoice Finance was named Best Factoring & Invoice Discounting Provider from 2006 to 2009 by Business Moneyfacts. In October 2008 Close Invoice Finance Limited won a Global Business Excellence (GBE) Award for Outstanding Technology Solutions for its IDeal invoice discounting and factoring system. In November 2008 Close Invoice Finance Limited won one of the most prestigious awards in the IT industry: a Computing Award for Excellence 2008 from Computing magazine, winning the category of Best Small Business IT Strategy for its IDeal invoice discounting and factoring system.Close Invoice Finance is a distinct business group within the Close Brothers Group, one of Europe’s most enterprising merchant banks and a FTSE top 250 listed company. Close Invoice Finance continues to grow at a rate that is ahead of the industry average and contributes more than 7% of the Close Brothers Group’s total revenue.

Great expectations lead to greater achievements:- The invoice discounting (asset based lending) solution

that Close Invoice To enable the business to work with customers whose

revenues were otherwise too small or their ledger composition too complex or high-risk to service safely and cost-effectively.

Asset based lending to provide a transparent view of the underlying debt structure of clients through invoice level access.

To improve service levels and provide self-service options for clients (through asset based lending).

Receivables financing to achieve greater account management efficiencies, Therefore, lower costs in order to be able to offer customers more flexible and more competitive pricing.

To increase overall control and significantly reduce risk (through asset based lending).

 CASE STUDY: THE TRANSACTION: TESCO/FOX FRESH EXPORT ZIMBABWE

Under this forfaiting transaction, the local company (Fox Fresh exports Zimbabwe) airfreights its flowers or fresh vegetables to a foreign buyer, in this case, Tesco Supermarkets in the United Kingdom.

Tesco issues a tenored promissory note to the exporter. These notes are then avalized by Tesco’s bank. Once the aval is added, the exporter, instead of waiting for 30 to 180 days for payment and/or borrowing money on the local market to finance his working capital needs, can approach a bank for immediate payment in foreign currency less a discount rate.

The exporter would then use the confirmed receivables backed by the aval of the bank as security and would thus receive payment 2 – 4 days after exporting.

 

PROCEDURE : Fox Fresh Exports Zimbabwe receives

confirmation of value of their exports and settlement dates from Tesco.

Fox Fresh Exports Zimbabwe instructs Tesco to issue promissory notes to be paid through its bank to Rabobank.

Tesco issues avalized promissory notes to the exporter.

Rabobank pays Fox Fresh Exports Zimbabwe less the discount (5%).

In 90 days Tesco’s bankers make final settlement with Rabobank.

ADVANTAGES IN THE TESCO/FOX FRESH EXPORT ZIMBABWE TRANSACTION

1. To the buyer (Tesco): Enjoy a bit of credit terms The buyer can now get the product, sell, receive money and invest it

before final settlement in 90 – 180 days.2. To the exporter (Fox Fresh Exports

Zimbabwe): Paid within 7 days of exporting. This facility does not require any rigorous

credit rating for Fox Fresh Exports Zimbabwe .

3. To the bank (Rabobank): Does not need to worry about country risk

(Zimbabwe risk). Facility is based on a transaction basis and

the risk that Rabobank is taking is with the foreign buyer Tesco, and not with Fox Fresh Exports Zimbabwe.

4. To the country (Zimbabwe): Zimbabwe, is now collecting its foreign

currency receipts faster than before, thereby improving on its balance of payments or foreign currency reserves.

FORFAITING

Forfaiting, or Medium-Term Capital Goods Financing, means selling a bill of exchange, at a discount, to a third party, the Forfaiter, who collects the payment from an, essentially, overseas customer, through a collateral bank(s), and, thus, assuming the underlying responsibility of exporters and simultaneously providing trade finance for importers by converting a short-term loan to a medium term one.

Done on a non - recourse basis Used for international trade transactions, usually for transactions not less than

$2,50,000 Tenor of instrument ranges from 180 days to 10 years payments are made

quarterly, semi-annually, annually Not so Popular as People are suspicious of its simplicity coupled with a lack of complex documentation

FORFAITING…

INFORMATION THE FORFAITER NEEDS

who the buyer is and his nationality;

what goods are being sold;

details regarding the value and currency of the contract;

the date and duration of the contract including the credit period

and number and timing of payments (including any interest rate

already agreed with the buyer)

evidence of debt that will be used (either promissory notes, bills

of exchange, letters of credit)

DOCUMENTS REQUIREDBY FORFAITER FROM EXPORTER

Copy of supply contract, or of its payment terms

Copy of signed commercial invoice

Copy of shipping documents including certificates of receipt,

railway bill, airway will, bill of lading or equivalent documents

Letter of assignment and notification to the guarantor

Letter of guarantee (standby letters of credit may also be used)

FORFAITING CHARGES

Forfaiters try to ensure that the buyer, not the seller, incurs

charges involved in a Forfait transaction.

Charges depend on

the level of interest rates relevant to the currency of the

underlying contract at the time of the Forfaiter's commitment

the Forfaiter's assessment of the credit risks related to the

importing country and to the avalizing (or guaranteeing) bank

DIFFERENCES

Forfaiting Export Factoring

The entire value of bill is discounted by forfaiter

Discounted value ranges between 75 – 85 %

Involvement of Availing Bank Export factor assesses credit worthiness

Purely a financing arrangement Also includes ledger administration, collection, etc

Exchange rate fluctuations are guarded against

Exchange rate fluctuations not guarded against