You are on page 1of 19

# FACTORING

&
FORFAITING

INTRODUCTION
• Leasing , HP & consumer credit are all fund based financial
services predicated upon Fixed Assets of the firm
• While factoring is predicated on receivables
• Can Bank factors limited is leading player with 55 % share while
SBI Factors & commercial services limited has a market share of
40%
• Factoring is sale of book debts by a firm “client” to financial
intermediary “factor” that he will pay for the debt as & when
they are collected or on a guaranteed payment date but a part
usually immediately to provide the liquidity to client
• Collection of receivables & maintenance of sales ledger

PRACTICAL PROBLEM
• SBI Factors advances Rs 14 lacs to ABC ltd against
agreement of providing advance payment of 80 % of
receivables & for guaranteed payment after 3 months. The
rate of interest is 16 % compounded quarterly & factoring
commission is 1.5 % of receivables. Both collected upfront
• Compute amount actually made available to ABC ltd
• Calculate effective cost of funds made available to ABC
• Assume interest is collected in arrear & commission in
advance what would be effective cost of funds

SOLUTION

A)
Value of factored receivable
Less commission

14/0.8
17.5 * 0.015

• Less interest
14 * 0.16 * 90/360)
• Funds made available to ABC
• B)
• Effective Interest as % of funds

17.50
14.00
0.26
13.74
0.56
13.18

0.56 / 13.18 *100
4.25%
( per quarter)
• Annualised rate of interest = [( 1 + i ) p – 1] * 100
• Annualised rate of interest [ ( 1.0425) 4 – 1 ] *100
18.11%

SOLUTION
• C)

Max permissible finance
Less commission
Funds available
Interest
14 * 0.16 * 90 / 360 )

• Effective Interest as % of funds

0.56 / 13.74 *100

• Annualised rate of interest [ ( 1.0408) 4 – 1 ] *100

14.00
0.26
13.74
0.56
4.08%
17.35%

FORMS OF FACTORING
• Recourse
– The factor has recourse over the client if debts become
irrecoverable
– Loss on irrecoverable debts is to be borne by client
• Non recourse
– Factor has no recourse to the client for irrecoverable debts
– Extra commission “del credere “ is charged
– Common on USA,UK but not in India

FORMS OF FACTORING
• Maturity factoring
– Factor does not make any advance payment
– Factor pays either on guaranteed date or on date of collection
– Factor charges commission

– Factor provides advance to client between 75-85 % of receivables
– Rest amount is held & known as “Factor Reserve”
– Factor charges commission & interest on advance too

FORMS OF FACTORING
• Bill / Invoice Discounting - Both factoring & bill discounting
make available finance against receivables but they are different
Transaction oriented & each bill is Pre payment against all unpaid &
separately discounted
non due invoices
No responsibility of sales ledger Factor is responsible for both
maintenance & collection of debts collection & maintenance of sales
ledger
No notice of assignment is
provided to customer of client

In factoring notice of assignment is
provided to customer of client

With recourse to client

May or may be Non recourse

Bills can be rediscounted several Factor cannot rediscount the
times. Last holder of bills receives receivables
full value of bills

FORMS OF FACTORING

Bill / Invoice Discounting

– Strictly it is not factoring as there is no sales ledger administration &
collection of Debts
– The facility of Bill discounting is kept confidential from customers
of client
– Hence referred as “Confidential factoring”
– Variant --- When factor bears risk of Bad debts (Non Recourse), it is
called as “Protected Invoice Discounting”
– If invoice discounting is not kept confidential then it is called as
“Bulk Factoring”
– Variant ---When factor bears risk of Bad debts (Non -Recourse), it is
called as “Agency Factoring”

FORMS OF FACTORING
• Full factoring
– Factoring arrangement which combines Advance factoring &
Non recourse
– It is also called as Old Line factoring
– Considers collection , sales ledger administration & short
term finance having Non recourse features
• Bank Participation Factoring
– Financing the Factor Reserve too by Bank
– Commercial Bank participates by providing an advance to
client against the reserves maintained by factor

FORMS OF FACTORING
• Supplier Guarantee Factoring
– Customer places order with Importer/Distributor
– Importer/distributor seeks approval of his factor for
extending credit to customers
– On getting approval, Importer/Distributor makes
arrangement of shipping of supplies from supplier to
customer
– Factor guarantees payment directly to supplier on
behalf of client ( Importer/Distributor)
directly makes payment to Supplier
– Builds greater confidence between Supplier- Importer /
Distributor relationship

FORMS OF FACTORING
• Cross Border Factoring
• Also called as International or export factoring
• Four parties-Exporter, Export factor ,Importer & Import Factor
– Exporter enters into agreement with Export factor domiciled in his
country & assigns him export receivables
– Export factor enters into arrangement with Import factor & contracts
out task of sales ledger maintenance & collection
– Import Factor collects amount from Importer & remits it to Export
Factor who gives it to Exporter

FACTORING / CREDIT INSURANCE
• Factoring
– involves sales ledger maintenance & collection
• Credit Insurance
– Insurance company merely settles down the claim arising on
account of insured account which have turned delinquent
(not exactly insolvent but overdue also)
– Insurance company specifies the maximum amount it will
cover on basis of credit rating
– Ex Dun & Bradstreet does credit rating for this purpose in
US

FORFAITING
Common form of financing export related receivables
Exporter sells goods to importer on deferred payment of 3-5 years
Importer draws a series of promissory notes inclusive of interest
These notes are avalled by Importer’s Banker ( endorsement by
Importer’s Banker in case of default)
• Exporter sells these avalled noted to forfaiter & gets 100 % finance
• Forfaiter holds these notes till maturity or sell it to group of investors
(secondary market)
• Forfaiter do not give other services like collection or sales ledger
maintenance

FACTORING

FORFAITING

• Usually 80 % is financed

100% financing

• Factor credit rates the counterparty in Non recourse cases

Forfaiting Bank relies on
avalling Bank

No such services

FUNCTIONS OF FACTOR
• Collection
– Sends statement of account to customers prior to &
collection letters around due dates
– Initiates personal collection efforts by personal letter,
telephonic contact & visiting premises when debts become
overdue
– Legal action if debt is irrecoverable
– Balancing method
• Transaction are recorder in chronological order
• Net amount carried forward
– Open item method
• Each receipt is matched with each invoice

FUNCTIONS OF FACTOR
• Credit protection
– In Non recourse factoring , the factor defines credit limit up to
which client can sell to customer
– Factor relies on
• Credit rating of customer
• Bank reports of customer
• Analysis of financial statements of customer
– Current ratio
– Quick ratio
– NP margin
– ROI
• Prior collection experiences with customers
• Customer premises visits

FUNCTIONS OF FACTOR
• Short term funding
– Factor finances usually 80 % keeping factor
reserve(20%) for sales returns & disputed Debts
– Advises client on customer’s perception of firm’s
product as Factor has expertise of client’s market
– Changes called in marketing strategies
– Emerging trends & how to respond them
– Audit of procedures followed for invoicing, delivery &
dealing with sales returns
– Provides introduction of factor with Bank of which
Factor is subsidiary for other financial services

FACTORING MASTER AGREEMENT
(LEGAL ASPECTS)
Client gives undertaking to sell all receivables
Client warranties that debts are valid, enforceable, undisputed &
recoverable
In Non Recourse factoring , bills approved falls within credit
limits authorised by factor
Client agrees to serve notice of assignment to customers
Client agrees to provide copies of invoices & credit notes to
factor
Factor acquires POA to assign receivables further
Time frame & termination of agreement
Customer is notified that he has to remit money to factor
Letter of disclaimer from Banker of factor that the same has not
discounted bills to avoid double financing