FACTORING

&
BILLS
DISCOUNTING
 FACTORING
1. FACTORING IS A POPULAR
MECHANISM OF MANAGING,
FINANCING AND COLLECTING
RECIEVABLES.

2. IT IS A METHOD OF CONVERTING A
NON PRODUCTIVE, INACTIVE ASSET
INTO A PRODUCTIVE ASSET BY
SELLING RECIEVABLES TO A COMPANY
THAT SPECIALISES IN THEIR
FACTORING SERVICES

1. CREDIT ADMINISTRATION

2. CREDIT COLLECTION AND

PROTECTION

3. FINANCIAL ASSISTANCE
 FACTORING & SHORT TERM
FINANCING
ALTHOUGH FACTORING PROVIDES SHORT TERM FINANCIAL
ACCOMADATION TO THE CLIENT, IT DIFFERS FROM OTHER TYPES
OF SHORT-TERM CREDIT IN THE FOLLOWING MANNER:

1. FACTORING PROVIDES FLEXIBLITY AS REGARDS CREDIT

FACILITY TO THE CLIENT. HE CAN OBTAIN CASH EITHER
IMMEDIATELY OR ON A DUE DATE OR FROM TIME TO TIME, AS AND
WHEN HE NEEDS CASH. SUCH FLEXIBILITY IS NOT AVAILABLE
FROM FORMAL SOURCES OF CREDIT.

2. FACTORING IS A UNIQUE MECHANISM WHICH NOT ONLY

PROVIDES CREDIT TO THE CLIENT BUT ALSO UNDERTAKES THE
TOTAL MANAGEMENT OF CLIENTS DEBTS.
 FACTORING & BILLS
DISCOUNTING
BILL DISCOUNTING OR INVOICE DISCOUNTING CONSISTS OF THE
CLIENT DRAWING BILLS OF EXCHANGE FOR GOODS & SERVICES
ON BUYERS, & THEN DISCOUNTING IT WITH BANK FOR A CHARGE.
THUS, LIKE FACTORING, BILL DISCOUNTING IS A METHOD OF
FINANCING.

LIMITATIONS:

1. BILLS DISCOUNTING IS A SORT OF BORROWING WHILE

FACTORING IS THE EFFICIENT AND SPECIALISED MANAGEMENT
OF DEBTS ALONG WITH ENHANCING THE CLIENTS LIQUIDITY.

2. THE CLIENT CANNOT BE PROTECTED FROM BAD DEBT.

3. BILLS DISCOUNTING IS NOT A CONVINIENT METHOD FOR

COMPANIES HAVING LARGE NUMBER OF BUYERS WITH SMALL
TYPES OF FACTORING
1. FULL SERVICE NON-
RESOURCE(OLD LINE).

2. FULL SERVICE RESOURCE

FACTORING.

3. BULK/AGENCY FACTORING
 COSTS & BENEFITS OF
FACTORING
TYPES OF COSTS INVOLVED:
1. FACTORING COMMISION OR SERVICE FEE,
2. INTREST ON ADVANCE GRANTED BY THE FACTOR TO
THE FIRM

BENEFITS OF FACTORING:
1. FACTORING PROVIDES SPECIALISED SERVICES IN
CREDIT MANAGEMENT,
2. FACTORING HELPS THE FIRM TO SAVE COSTOF
CREDIT ADMINISTRATION.
QUESTION:
A SMALL FIRM HAS A TOTAL CREDIT SALES OF
Rs. 80 LAKHS & ITS AVG. COLLECTION PERIOD IS
80 DAYS. THE PAST EXPERIENCE INDICATES
THAT BAD-DEBTS LOSSES ARE AROUND 1% OF
CREDIT SALES. THE FIRM SPENDS ABOUT Rs.
1,20,000 P.A. ON ADMINISTERING ITS CREDIT
SALES. THIS COST INCLUDES SALARIES OF ONE
OFFICER, & TWO CLERKS WHO HANDLE CREDIT
CHECKING, CLLECTION, ETC. THESE ARE
AVOIDABLE COST. A FACTOR IS PREPARED TO
BUY A FIRM’S RECIVABLES. HE WILL CHARGE 2%
COMMISION. HE WILL ALSO PAY ADVANCE
AGAINST RECIEVABLES OF THE FIRM @ OF 18%
INTREST AFTER WITHOLDING 10% AS RESERVE.
WHAT SHOULD THE FIRM DO?
1ST CALCULATE AVG LEVEL OF RECIEVABLES
AVG LEVEL OF RECIEVABLES =80,00,000/360 X 80 = Rs. 17,77,778

FACTORING COMMISION = 0.02 X 17,77,778 = Rs. 35,556

RESERVE = O.10 X 17,77,778 = Rs. 1,77,778

THEREFORE ADVANCE AVAILABLE = Rs.(17,77,778 – 35,556 – 1,77,778) = Rs. 15,64,444

HOWEVER, THE FACTOR WILL DEDUCT 18% INT BEFORE PAYING THE ADVANCE FOR 80 DAYS.

ADVANCE PAID = 15,64,444 – (0.18 X 15,64,444 X 80/360) = Rs. 15,01,866

ANNUAL COST: FACTORING COMMISION 35,556 X 360/80 = Rs. 1,60,002

INTREST CHARGES 62,578 X 360/80 = Rs. 2,81,601
Rs. 4,41,603

THE FIRM SAVES THE FOLLOWING COSTS:

COST OF CREDIT ADMINISTRATION = Rs. 1,20,000
COST OF BAD DEBTS LOSS = Rs. 80,000
Rs. 2,00,000

NET COST OF FACTORING Rs. 4,41,603 – Rs. 2,00,000 = Rs. 2,41,603

EFFECTIVE RATE OF ANNUAL COST = Rs. 2,41,603/ Rs. 15,01,866 = .016 OR 16%

THE ANNUAL % COST OF 16% OF FACTORING RECIEVABLES CAN BE COMPARED WITH THE COST OF
OTHER POSSIBLE SOURCES OF SHORT TERM FINANCING
THE ADVANCE WHICH THE FACTOR WILL PAY WILL BE THE AVG.
LEVEL OF RECIEVABLES – FACTORING COMMISION – INTREST ON
ADVANCE. THE FACTORING COMMISION IS 2% OF AVERAGE
RECIEVABLES (80 DAYS)