Factoring

BASICS
 Factoring in India:

 Factoring is of recent origin in Indian Context.

 Kalyana Sundaram Committee recommended introduction of factoring in 1989.
 Banking Regulation Act, 1949, was amended in 1991 for Banks setting up factoring services.
 RBI has permitted Banks to undertake factoring services through subsidiaries.
 SBI/Canara Bank have set up their Factoring Subsidiaries:-
a. SBI Factors Ltd., (April 1991)
b. CanBank Factors Ltd., (August 1991).
Definition:

Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on
the understanding that the Factor will pay for the Book Debts as and when they are
collected or on a guaranteed payment date. Normally, the Factor makes a part payment
(usually upto 80%) immediately after the debts are purchased thereby providing immediate
liquidity to the Client.
Basics of Factoring:
Factoring in finance is a source of immediate capital. It is
acquired in exchange for accounts receivable.

It is a financial arrangement between a financial institution

(factor) and a small or medium-sized firm (client).

A factor purchases trade debts or receivables from a client firm

at a discounted price.
FACTORING
MEANING:
Factoring is a financial transaction in which a business sells its
accounts receivable to a third party at a discount. It is mainly
done to meet it's present and immediate cash needs.

Factoring is a transaction in which a business sells its

invoices, or receivables, to a third-party financial company
known as a “factor.” The factor then collects payment on
those invoices from the business’s customers. Factoring is
known in some industries as “accounts receivable financing.”
Parties to Factoring:

The factor, is the The client, is the firm

The debtor, therefore,
financial institution that that sells its receivables;
ends up paying the
offers finance to a client the debtor is the party
factor instead of the
(in exchange for who owes the trade
original business.
receivables). debt.
SERVICES OFFERED BY A
FACTOR:

1. Follow-up and collection of Receivables from Clients.

2. Purchase of Receivables with or without recourse.

3. Help in getting information and credit line on customers (credit protection)

4. Sorting out disputes, if any, due to his relationship with Buyer & Seller.
Process involved in factoring:

Client concludes a credit sale with a customer.

 Client sells the customer’s account to the Factor and notifies the customer.
Factor makes part payment (advance) against account purchased, after adjusting for commission
and interest on the advance.
Factor maintains the customer’s account and follows up for payment.
Customer remits the amount due to the Factor.
Factor makes the final payment to the Client when the account is collected or on the guaranteed
payment date.
MECHANICS OF FACTORING:
The Client (Seller) sells goods
to the buyer and prepares
invoice with a notation that
debt due on account of this
invoice is assigned to and
must be paid to the Factor
(Financial Intermediary).
The drawing limit is adjusted
on a continuous basis after
taking into account the
collection of Factored Debts.
The Client (Seller) submits
invoice copy only with
Delivery Challan showing
receipt of goods by buyer, to
the Factor.
Once the invoice is honoured
by the buyer on due date, the
Retention Money credited to
the Client’s Account.
The Factor, after scrutiny of
these papers, allows payment
(,usually upto 80% of invoice
value). The balance is
retained as Retention Money
(Margin Money). This is also
called Factor Reserve.
Till the payment of bills, the
Factor follows up the
payment and sends regular
statements to the Client.
CHARGES FOR FACTORING
SERVICES:

Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to
1.50%)
 Commission is collected up-front.

For making immediate part payment, interest charged. Interest is higher than rate of
interest charged on Working Capital Finance by Banks.
If interest is charged up-front, it is called discount.
MECHANICS OF FACTORING
The client sells goods to the buyer and prepares invoice with a notation that Debt due
on account of this invoice is assigned to and must be paid to the factor (financial
intermediary)

The client submits invoice copy only with delivery challan showing receipt of goods
By buyer, to the factor

The factor, after scrutiny of these papers allows payment (usually up to 80% of the
invoice value.) The balance is written as retention money (margin money) this is also
called factor reserve
Why sell Receivables?

They need cash and don’t want to (or cannot) wait until their own clients pay invoices.

They don’t want to deal with the credit risk of their clients.

They don’t want to employ people who try to call clients, remind them about due dates and
missing payments – in other words, they don’t want to bother with collecting of receivables.

They are trying to “window-dress” their financial statements, just as my client did – but in
reality, it does not happen very often.
Example:
Let's understand factoring with the help of an example.
You own a business, and you have accounts receivable
pending with you which will be due after three months.
But in the meantime, you need access to cash to address
immediate liquidity needs.
Example:
To gain access to cash, you approach a factor or a financial
institution who has agreed to purchase your invoice worth Rs
10,00,000 from ABC Ltd. The factor may choose to discount the
invoice at 4 per cent and will keep RS 40,000 as part of his/her
commission. The balance amount is Rs 9,60,000.

Now, the factor might not advance the entire amount of Rs 9,60,000.
It would only give around 75 per cent of that which is Rs 7,20,000 in
the first tranche and the rest (Rs 2,40,000) when the financial
institution receives balance payment from the customer.
 Due date of Receivable (Longer time frame will require
more factor fees compared to a shorter time frame).

The industry that the business belongs.

Under Factoring, the
discount (factor fees)
charged by The creditworthiness of Business Credit Customers;
companies depends
on multiple factors, Collection history of the business on its receivables;
namely:
Amount of Invoice Factoring assigned for factoring.

Type of Factoring-Recourse or Non-Recourse

 Factoring period is 90-150 days

Costly source of finance

FEATURES Bad debts will not be considered

OF
FACTORING Credit rating is not mandatory

Method of Off -balance sheet financing

Cost of factoring = finance cost +

operating cost
 NON-
RECOURSE ADVANCE
RECOURSE
FACTORING FACTORING
FACTORING

BANK NOTIFIED AND

MATURING
PARTICIPATION UNDISCLOSED
FACTORING
Types of
FACTORING FACTORING

factoring: FULL INVOICE

BUYER-BASED,
SELLER-
BASED, AND
FACTORING FACTORING
SELECTIVE
FACTORING

EXPORT
FACTORING
 Recourse Factoring:
Up to 75% to 85% of the Invoice Receivable is factored.

Interest is charged from the date of advance to the date of collection.

Factor purchases Receivables on the condition that loss arising on account of non-
recovery will be borne by the Client (seller firm).

Credit Risk is with the Client.

Factor does not participate in the credit sanction process.

In India, factoring is done with recourse.

NON-RECOURSE FACTORING:
Factor purchases Receivables on the condition that the Factor has no
recourse to the Client, if the debt turns out to be nonrecoverable.

Credit risk is with the Factor.

Higher commission is charged.

Factor participates in credit sanction process and approves credit limit given
by the Client to the Customer.

In USA/UK, factoring is commonly done without recourse

 Factor does not make any advance payment to the
Client.

Pays on guaranteed payment date or on collection of

Receivables.
MATURITY Guaranteed payment date is usually fixed taking into
FACTORING account previous collection experience of the Client.

Nominal Commission is charged.

No risk to Factor.
 Canbank Factors Limited

SBI Factors and Commercial Services Pvt. Ltd.

The Hongkong and Shanghai Banking Corporation

FACTORING Ltd.

COMPANIES Foremost Factors Limited

IN INDIA Global Trade Finance Limited

Export Credit Guarantee Corporation of India Ltd.

Small Industries Development Bank of India (SIDBI)

  Indian Contract Act
STATUTES  Sale of Goods Act
APPLICABLE  Transfer of Property Act
TO
 Banking Regulation Act.
FACTORING
 Foreign Exchange Regulation Act