Invoice or Bill Discounting or Purchasing Bills Features source of working capital finance for the seller of goods on credit; business vertical for all types of financial intermediaries, provides credit period for the buyer arrangement whereby the seller recovers an amount of sales bill from the financial intermediaries before itis due fora fee selling of bill to discounting company before the due date of payment at a value which is less than the invoice amount. fee will depend on the period left before payment date, amount and the perceived risk (quality of debtors of the seller), financial standing of the customer, his credit worthiness. The bills or invoices under bill discounting are legally the ‘bill of exchange” This works like a bank overdraft the borrower pays the interest only on the amount of money utilized. Process 1 Sells goodson credit [= | LC) 5 Repay amt to selleron expiry of credit period oat Bill Discounting or Invoice Discounting Process/Procedure The seller sells the goods on credit and raises invoice on the buyer. ‘The buyer accepts the invoice. By accepting, the buyer acknowledges paying on the due date. Seller contacts his bank for Bill Discounting Facility by endorsing the Bill of Exchange in favour of Bank. The financing company assures itself of the legitimacy of the bill and creditworthiness of the buyer. The financing company avails the fund to the seller immediately after deducting appropriate margin, discount and fee as per the norms.‘The seller gets the funds and uses it for further business. On the due date of bill of exchange, Buyer pays to the Seller and Seller in tun pays whole amount to the Bank. Sometimes, the financial intermediary collects the money from the buyer. ‘Who will collect the money’ depends on the agreement between the seller and financing company. Seller pays total amount of BVE to the financing company. Advantages of Bill Discounting Seller gets his money instantly by which he won't have to face the opportunity loss; receivable cycle gets shortened; No collateral security required; involves quick processing with hassle free documentation; Buyer gets as longer credit petiod as possible. Disadvantages of Bill Discounting Duc to bill discounting, Seller's profit margin gets reduced by discounting charges Risk of default bome by bank in without recourse facility. Some Banks discount only Commercial Bill and not every bill; not useful for long term working capital purpose; Banks give Bill discounting to his regular satisfactory customers. Hence, this facility may not be available for a new business entity, Types of Bill Discounting Undisclosed/ Confidential Bill Discounting In this Bill Discounting, the Seller delivers goods to the Buyer and raises invoice. Buyer confirms the invoice. Seller approaches Discounting Firm or Bank for discounting with confirmed invoice. Bank discounts the invoice and after deducting discounting charges from the invoice value, pay the remaining value to the Seller. On due date of invoice, the Buyer pays 100% of invoice value to the Seller and Seller in turn pays the same to the Discounting Firm and Bank. Here, Buyer is not aware about the discounting the seller has done with the Bank. Disclosed/Non- Confidential Bill discounting In this type of Bill Discounting, MNC Buyer is aware about the bill discounting done by MSME Seller. Here, MSME Seller delivers goods to MNC Buyer and raises invoice. MNC confirms the invoice and MSME Seller shares the confirmed invoice with the discounting firm or bank. Bank after collectingdiscounting charges from invoice, pay the remaining amount to the MSME Seller immediately. On due date, the MNC Buyer pays the 100% of the invoice value to the discounting firm or Bank. Invoice/Bills presenting methods ‘There are two methods to present the bills to the buyer's bank — with recourse and without recourse. With recourse bill discounting: In this method of Bill Discounting, the Séller takes the responsibility of non-payment of invoice by the Buyer. If the buyer does not pay the invoice, the seller will make payment to the Bank. Here Bank is not liable to collect payment from buyer. Without recourse bill discounting: Here Bank takes the entire responsibility of recovery of bill / invoice from the Buyer and seller is free from his responsibility to recover money from buyer. Without recourse bill discounting is costlier than with recourse bill discounting, Factoring Definition Factoring provides a line of credit along with collection services. Factoring is a financial service in which the business entity sells its bill receivables to a third party/ outside agency at a discount in order to raise funds. Such an agency is called a factor. ‘Types of Factoring Recourse Factoring Factor has recourse in the event of default by buyer. Seller will compensate the factor, i.e, seller bears the credit risk. Non-recourse Factoring The Factoring provides all types of facilities except debt protection. Factor has no Fecouse in the event of default by buyer. Factor will have to bear the credit risk. Disclosed Factoring Buyer is informed of the appointment of factor and pays directly to the factor Undisclosed Factoring Buyer is unaware of the appointment of factor and pays directly to the seller.Maturity Factoring/ Collection Factoring Under this arrangement, except providing finance, all other basic characteristics of factoring are present, ‘The payment is effected to the seller at the end of collection period or the day of collecting accounts whichever is earlier. Advance Factoring (undisclosed/ no collection services) Under this arrangement, the Factor provides advance at an agreed rate of interest to the client on uncollected and non-due receivables. Under this method, the buyer is unaware of factoring arrangement. Debt collection is organized by the seller who makes payment of each invoice to the factor, if advance payment had been received earlier. This could be with or without recourse. Agency Factoring (no collection service, credit and recourse available) Under this arrangement, the facilities of finance and protection against bad debts are provided by the Factor whereas the Sales ledger administration and collection of debts are carried out by the seller. Full Factoring Itis the most comprehensive type of facility offering all types of services namely finance, credit protection, sales ledger administration, collection, advisory services. It is a type of recourse factoring. Domestic Factoring Itis undertaken for financing receivables within a country and involves one factor. Cross-border Factoring Seller sells goods and services to the customer and delivers the invoices, order, etc., to the Factor and informs the customer of the same. In return, the Factor makes a cash advance and forwards a statement to the seller. The Factor then sends a copy of all the statements of accounts, remittances, receipts, ete., to the customer. On receiving them the customer sends the payment to the Factor. Limited Factoring Factor discounts only certain invoices on selective basis and converts credit bills into cash in respect of those bills only. Functions of Factor 1. Maintenance of Sales Ledger A factor is responsible for maintaining the sales ledger of the client. So the factor takes care of all the sales transactions of the client. 2. Collection of Money‘The factor performs the duty of collecting funds from the client’s debtors. This enables the client to focus on core areas of business instead of putting energies in the collection of money. Financing The factor finances the client by purchasing alll the account receivables. Credit Protection In the case of non-recourse factoring, the risk of non-payment or bad debts is on the factor. Advisory Services By virtue of their experience and ac the client, s to extensive credit information, Factor is able to advise Factoring Process L BEN Factor and client enter into an agreement after evaluating the credit worthiness of customers; fixes limits The seller makes the sale of goods or services and generates invoices for the same. The business then sells all its invoices to a third party called the factor. The factor pays the seller, after deducting some discount on the invoice value. The rate of discount in factoring ranges from 2 to 6 percent. However, the factor does not make the payment of all invoices immediately to the seller. Rather, it pays only up to 75 to 80 percent of the invoice value after deducting the discount. Factor maintains the sales ledget and periodically follows up with customers. On due date, buyer pays the factor, full amount of bill due. Factor then pays the remaining 20 to 25 percent of the invoice, called factor reserve after recovering interest and other charges called factorage.SELLER FACTOR fn Advantages of Factoring Itreduces the credit risk of the seller. Sales ledger maintenance by the factor leads to a reduction of cost. ‘There is a saving of administration or collection cost. Improves liquidity and cash flow in the organization. The working capital cycle runs smoothly as the factor immediately provides funds on the invoice. Helps to offer longer eredit terms to the sellers, eventually raising sales It reduces the need for the introduction of new capital in the business.Disadvantages of Factoring Factor collecting the money on behalf of the company can lead to stress in the company and the client relationships. Bad behavior of factor with the debtors can hamper the goodwill of the company. The cost of factoring is very high Factors often avoid taking responsibility for risky debtors. So the burden of managing such debtor is always in the company, The company needs to show all the details about company customers and sales to factor Seller may not receive full amount non invoice in the beginning. Difference Factoring Bill Discounting ‘Onus of checking on the sales ledger, control of credit and chasing your clients for paying back. ‘The work of collection and follow up is ‘outsourced to the bank. Bill discounting requires your own a team to take care of the sales invoice, follow-ups ‘counts Money is paid to factor; the client settles their payables with the factor Money is paid to seller; client will not really know the involvement of a third part Receivables are sold Only bill is transferred, asset not sold Factor companies can release the money within 24 hours to the seller. Only 85% is advanced first called as “Advance Rate”. The remaining of the face value of invoice can be paid once the buyer’s payment is received by the seller's bank, rest on actual payment by buyer The drawer company (which is the seller) receives the amount minus a small discount immediately in a bill discounting useful for larger businesses where an entire line- up of client credits have to be managed, fal for small businesses Bank charges commission along with interest Higher charges The bank receives discounting charges for the credit/ Comparatively lower charges Factor may be a bank or any financial institution’ Bills are usually discounted with banks Provides collection, advisory and debt management services Does not provide any such services Existence of Factoring Agreement None Factoring Securitisation financial institution purchases the book debts of a compan ‘SPV purchases the debts of a financial institution three parties that is the factor, buyer and the seller four parties that and investor originator, spy, borrower Deals with short term receivables ranging upto 6 months Deals with long term receivablesFactoring can be done with or without recourse | Done only without recourse No credit rating Requires credit ratin Fund + Fee based services Fund Based Service Forfaiting Features + isan international supply chain financing method and a technique of financing export credit known as “structured trade finance” in US ‘* Forfaiters finance medium and long-term bills receivables. So, the credit period can be between six months to seven years. 100% financing paid in one instalment unlike factoring ‘without recourse to the seller of the debt (Exporters sell their debts under a forfaiting agreement on without recourse basis, which means that once the debt is sold the non-payment risk passes to the forfaiter.) ‘* The payment obligation is often but not always supported by a bank guarantee. In most cases, the forfaiters seek a guarantee from the importer’s bank. Such a guarantee is provided by the Importer’s bank in the form of a letter of credit, ‘* Forfaiting involves large amounts - Transaction values can range from US$100,000 to US$200 million ‘normally represented by negotiable instruments such as promissory notes or bills of exchange ‘Debt instruments are typically denominated in one of the world’s major currencies, with Euro and US Dollars being most common. ‘Finance can be arranged on a fixed or floating interest rate basis. ‘* usually done by banking and financial institutions who specialize in import export financing. ‘© Forfaiting companies can finan ‘+ The forfaiters may or may not include more than just purchasing the bill. They help structure the deals, the credit terms, the guarantees sought, and deciding the pricing structure. the project in any of the major currencies.Parties and Forfaiting Process Basic Forfaiting Transaction Exporter Importer 2- Sales Contract between Exporter and Importer Importer sends documents to exporter sei] ig lis fa] Ff ae eH 28 si] =! 24 Ea ge gs Z sai ff |es ag tG! Sa) 8% 1g * Ez) g a : 4 5 of 4 PY" b-Forfeiter presents documents to bankat 4 4 maturity Primary Forfaiter 10- Bank pays to forfetter at maturity Bank At me ee Forfaiting Agreement, Sales Contract (12) Shipment (3) BGINI Issue and Transfer (4.5) Discounting (6,7) ‘Repayment on Maturity (8,9,10) Step 1 : Forfaiter and Exporter agreed upon a Forfaiting Agreement to discount on a non-recourse basis his claims under the LC. Step 2 : Sales Contract has been signed between Exporter and Importer. Step 3 : Shipment is initiated by the exporter as per LC. the seller must take care that all LC terms have been satisfied and that all documents complied with; evidence of that is needed for the forfaiter to materialise the transaction. Step 4: The importer sends documents to exporter Step 5 : Exporter gives documents to forfeiter ( NI). Step 6 : Forfaiter controls the documents pays for them as indicated on the Forfaiting Agreement.Step 7 : Forfaiter presents documents to importer bank at maturity date. Step 8 : Importer pays to bank at maturity date. Step 9 : Bank pays to forfaiter at maturity date, g with LC (Shipment only after LC is received; Document Transfer; All transactions routed through banks.) Forfaiting Agreement, Sales Contract (1,2) LC Issue and Transfer (4,5) Shipment Doe Transfer Discounting (6,7) ‘Repayment on Maturity (8,9,10) Step 1 : Forfaiter and Exporter agreed upon a Forfaiting Agreement to discount on a non-recourse basis has claims under the LC. Step 2 : Sales Contract has been signed between Exporter and Importer. Step 3 : The importer obtains a guarantee (LC)from his bank. Step 4 : The importer bank sends LC to exporter bank.Step 5 : Exporter Bank sends LC to Exporter. Step 6 : Shipment is initiated by the exporter as per LC. The seller must take care that all LC terms have been satisfied and that all documents are complied with; evidence of that is needed for the forfaiter to materialise the transaction, Step 7: Shipment Documents are transferred to the exporter through importer’s Bank and exporter’s. bank. Step 8 : Exporter gives documents to forfaiter (can be advising bank or any other NBFC)- (LC & NI). Step 7 : Forfuiter controls the documents, pays for them as indicated on the Forfaiting Agreement, Step 8 : Forfaiter presents documents to importer’s bank at maturity date. Step 9 : Importer pays to bank at maturity date. Step 10 : Importer Bank pays to forfaiter at maturity date. Advantages of Forfaiting: Forfaiting sets the exporter free from the Fisk Of non-payment by the importer. It becomes the bank’s (forefaiter’s) headache to collect the payments. The exporting firm can concentrate its energies on growing the business rather than chasing due Forfaiting also shields the exporter from the adverse risk arising due to foreign exchange rate ‘luctuations. This risk arises when the deal is signed in the domestic currency of the importer. So, no rreney is, he will pay the exact amount only, Now, if the importer’s currency depreciates, the same amount will convert to a lesser sum in the exporter’s currency. This can possibly result in losses for the exporter. But forfaiting absolves the exporter from this risk. matter what the prevailing foreign exchange rate of the importer’s domestic Forfaiting makes for an easy Sourée Of funds for exporters. Payments involved in cross-border transactions are usually large, and goods are generally sold on credit terms. So, a new firm entering the exporting business may not have the quantum of funds to sustain their business. Forfaiting on the other hand provides such businesses with financial support to continue their business. Forfaiting helps exporters to offer longer eredit terms to their foreign customers. This helps the exporter to get more and more customers on board while maintaining a steady flow of funds. The profits made by selling to an additional customer because of longer credit terms can largely compensate for the discounting charges. Limitations/ Disadvantages of Forfaiting Though forfaiting protects the exporter from many of the risks, forfaiters charge considerably for undertaking this risk. This harge, oF Service fee, is higher than other commercial credit charges. Thistranslates into higher costs for the exporter. Usually, the exporter tries to push these costs into the deal price but there will be a limit to that Another limitation arises from the fact that forfaiters typically chose to finance only those projects which come from major developed economies. They do so to save themselves of the risk of non- availability of foreign exchange with the developing countries. Additionally, only those currencies are taken into forfaiting which have high international liquidity. These factors limit the exporters ability to enjoy the services of such institutions. Since, the exporter is not liable in case the importer defaults, the forfaiter runs the risk of making heavy losses in case the importing firm goes bankrupt. Hence, itis important for forfaiters to determine the paying capacity of the importer. They do so by looking at typical financial indicators like total assets ‘owned by the importer, total debt and other liabilities, credit score, ete. Another way of taking care of this risk is by seeking a letter of credit from the importer’s domestic bank. ‘Non availabiliy of f62Sign GXEHAAKE with the importers’ country, o i the importers country gets into a war with some country, Both these factors are risky and inflict huge damage to the forfaiter’s liquidity and profitabilit Difference Factoring Forfaiting With or without recourse Without recourse Small amount Large amount Short maturit Long Maturity No LC LC is involved Domestic Intemational Tn Instalments ‘At once 3 Parties 4 Parties (Respective Banks are involved) Factor is paid by buyer Forfaitor is paid by Importer’s bank ‘Transactions between sellers Transactions routed through banks