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Factoring is a type of financial service provided by the specialist
organizations. When small scale firms sell on credit basis, collection of receivable
poses a problem. In that case factoring organizations play an important role in
collection of debtors. Factoring involves sale of receivables to specialized firm,
called factors. Factors collect receivables and also advance cash against
receivables to solve the client firms liquidity problem. For providing their
services, they charge interest on advance and commission for other services. In
other words, factoring is an arrangement under which a financial institution (called
factor) undertakes the task of collecting the book debts of its client in return for a
service charge in the form of discount or rebate. The factoring institution
eliminates the clients risk of bad debts by taking over the responsibility of book
debts due to the client. The factoring institution advances a proportion of the value
of book debts of the client immediately and the balance on maturity of book debts.

Factoring is a service involving the purchase by a financial organization,
called a factor, of receivables owned to manufacturer and distributors by their
customers, with the factor assuming full credit and collection responsibilities.
Factoring is a service of financial nature involving the conversion of credit
bills into cash.

Characteristics of factoring
1. Usually the period for factoring is 90 to 150 days. Some factoring companies
allow even more than 150 days.

2. Factoring is considered to be a costly source of finance compared to other

sources of short term borrowings.
3. Factoring receivables is an ideal financial solution for new and emerging
firms without strong financials. This is because credit worthiness is evaluated
based on the financial strength of the customer (debtor). Hence these
companies can leverage on the financial strength of their customers.
4. Bad debts will not be considered for factoring.
5. Credit rating is not mandatory. But the factoring companies usually carry out
credit risk analysis before entering into the agreement.
6. Factoring is a method of off balance sheet financing.
7. Cost of factoring=finance cost + operating cost. Factoring cost vary
according to the transaction size, financial strength of the customer etc. The
cost of factoring varies from 1.5% to 3% per month depending upon the
financial strength of the client's customer.
8. Indian firms offer factoring for invoices as low as 1000Rs
9. For delayed payments beyond the approved credit period, penal charge of
around 1-2% per month over and above the normal cost is charged (it varies
like 1% for the first month and 2% afterwards).

A factor provides finance to his client upto a certain percentage of the
unpaid invoices which represent the sales of goods or services to approved
customers. The mechanism of the factoring scheme is as follows:

There should be a factoring arrangement (invoice purchasing arrangement)

between the client(which sells the goods and services to trade customer in
credit) and the factor, which is the financing organization.
Whenever the client sells goods to the trade customers on credit he prepares
invoices in the usual way.
The goods are sent to the buyers without raising a bill of exchange but
accompanied by an invoice.
The debt due by the purchaser to the client is assigned to the factor by
advising the trade customers to pay the amount due to the client, to the
The client hands over the invoices to the factor under cover of a schedule of
offer along with the copies of invoices and receipted delivery challans.
The factor makes an immediate payment upto 80% of the assigned invoices
and the balance 20% will be paid on realization of the debt.


credit sale of



Pays the

Pays the amount (In recourse

type customer pays through

Submit invoice

Payment up to
80% initially



Assignment of debt in favor of the factor,

Selling limits for the client,
Conditions within which the factor will have recourse to the client in case
of non-payment by the trade customer,
Circumstances under which the factor for his services, say for instance, as
a certain percentage on turnover,
Interest to be allowed to the factor on the account where credit has been
sanctioned to the supplier, and
Limit of any overdraft facility and the rate of interest to be charged by

Purchase and collection of debt
Sales ledger management
Credit investigation and undertaking of credit risk
Provision of finance against debts
Rendering consulting services

Recourse and Non-recourse Factoring

Under a recourse

factoring arrangement, the factor has recourse to the client (firm) if the debt
purchased/receivables factored turns out to be irrecoverable. If the customer defaults in
payment, the client has to makes good the loss incurred by the factor. The factor charges
the client for maintaining the sales ledger and debt collection services and also for the
interest for the period on the amount drawn by the client.
The factor does not have the right of recourse in the case of non-recourse factoring.
The loss arising out of irrecoverable receivables is borne by him, as a compensation
which he charges a higher commission.

Advance and Maturity Factoring

A drawing limit, as a pre-payment,

is made available by the factor to the client as soon as the factored debts are approved.
The client has to pay interest on the advance between the date of such payment and the
date of actual collection from the customers.
The maturing factoring is also known as Collection factoring. Under such
arrangements, the factor does not make a pre-payment to the client. The payment is made
either on the guaranteed payment date or on the date of collection.

Full Factoring

This is the most comprehensive form of factoring combining the

features of almost all the factoring services specially those of non-recourse and advance
factoring. Full factoring provides the entire spectrum of services (collection, credit
protection, sales ledger administration and short term finance).

Disclosed and Undisclosed Factoring

In disclosed factoring, the

name of the factor is disclosed in the invoice by the supplier-manufacturer of the goods
asking the buyer to make payment to the factor. The supplier may continue to bear the
risk of non-payment by the buyer without passing it on to the factor.
The name of the factor is not disclosed in the invoice in undisclosed factoring
although the factor maintains the sales ledger of the supplier manufacturer. The entire
realization of the business transaction is done in the name of Supplier Company but all
control remains with the factor. He also provides short-term finance against sales invoice.

Domestic and Export/Cross-Border/International Factoring

In the domestic factoring, the three parties involved, namely, customer(buyer),
client(seller-supplier) and factor (financial intermediary) are domiciled in the same
The process of export factoring is almost similar to domestic factoring except in
respect of the parties involved. There are usually four parties involved in cross-border
factoring transaction. They are: exporter (client), importer (customer), export factor and
import factor.

Benefits of Factoring to Clients
1) Under the factoring arrangement the client receives prepayment upto 80-90
percent of the invoice value immediately and the balance amount after the
maturity period. This helps the client to improve cash flow position which
enables him to have better flexibility in managing working capital funds in
an efficient and effective manner.
2) If the client avails the services of the factor in respect of sales ledger
administration and collection of receivables, he need not have any
administrative set up for this purpose. Naturally this will result into a
substantial saving in time and cost of maintaining own sales ledger
administration and collecting receivables from the customer. Thus, it will
reduce administrative cost and time.
3) When without recourse factoring arrangement is made, the client can
eliminate the losses on account of bad debts. This will help him to
concentrate more on maximizing production and sales. Thus, it will result
in increase in sales, increase in business and increase in profit.

The client can avail advisory services from the factor by virtue of his
expertise and experience in the areas of finance and marketing. This will
help the client to improve efficiency and productivity of his organization.
Besides this, with the help of data base, the factor can readily provide
information regarding product design/mix, prices, market conditions etc., to
the client which could be useful to him for business decisions.

The above mentioned benefits will accrue to the client provided he develops a
better business relationship with the factor and both of them have mutual trust in
each other.

Disadvantages of Factoring

1) Image of the client may suffer as engaging a factoring agency is not considered
a good sign of efficient management.
2) Factoring may not be of much use where companies or agents have one time
sales with the customers.
3) Factoring increases cost of finance and thus cost of running the business.
4) If the client has cheaper means of finance and credit (where goods are sold
against advance payment), factoring may not be useful.


Sunlight industries ltd. manages its account receivables by its sales and
credit department. The cost of sales ledger administration stands at Rs 9 crore
annually. It supplies chemicals to heavy industries. These chemicals are used as
raw material for further use or are directly sold to industrial units for consumption.
There is a good demand for both the types of uses. For the direct consumers, the
company has a credit policy 2/10, net 30. Past experience of the company has been
that on avg. 40% of the customer avail of the discount while the balance of the
receivables are collected on an avg. 75 days after the invoice date. Sunlight
industries also has small dealer networks that shall the chemicals bad debt of the
company are currently 1.5% of total sales.
Sunlight industries finances its investment in debtors through a mix of bank
credit and own long term funds in the ratio of 60:40 current cost of bank credit and
long term funds are 12% and 15% respectively.
There has been a consistent rise in the sales of company due to its proactive
measures in cost reduction and maintaining good relations with dealers and
customers. The projected sales for the next year are Rs 800 crore of 50% from last
year. Gross profits have been maintain at a healthy 22% over the years and are
expected to continue in futures.
With escalating cost associated with the in-house management of debtors
coupled with the need to unburden the management with the task so as to focus on

sales promotion, the CEO of Sunlight Industry examine the possibility of

outsourcing its factoring service for managing its receivables. He assigns the
responsibility to Anita Guha, the CFO of Sunlight. Two proposals the details of
which are given below are available for Anitas consideration.
Proposal from Canbank Factors Ltd.: The main element of the proposal
are :

Guaranteed payment within 30 days


Advance, 88% and 84% for the recourse and non-recourse arrangement


Discount charge in advance 21% for recourse and 22% without recourse


Commission, 4.5% without recourse and 2.5% with recourse

Proposal from Indbank Factors:


Guaranteed payment within 30 days


Advance 84% with recourse and 80% without recourse


Discount charge upfront, without recourse 21% and with recourse 20%


Commission upfront, without recourse 3.6% and with recorse 1.8%

The opinion of the chief Marketing manager is that in context of the factoring
arrangement his staff would be able to exclusively focus on sales promotion which
would result on additional sales of Rs 75 crore.

(A) In house Management :

Cash discount(Rs 800 croreX0.40X0.20)
Bad debts (Rs 800 croreX0.015)

Rs 6.4

Opportunity Cost (Forgone contribution on lost sales) [Rs 75 croreX0.205 net of

bad debts]


Avoidable administrative and selling expenses


Cost of investment in receivables


Total Cost


Avg. collection period (0.40X10days)+(0.60X75days)=49 days

Investment in debtors: (Rs108.9X0.60X0.12)+ (Rs108.9X0.40X0.15)= Rs 14.4 crore

(B) Canbank factors Proposal:

With recourse

Without recourse





[(Rs 875 crore-Rs750.7 crore)X0.15X30/360]


[(Rs 875 crore-Rs701.9 crore)X0.15X30/360]




Factoring Commission (Rs 875 croreX0.025)

(Rs 875 croreX0.045)
Discount charge(Rs 750.7*croreX.21X30/360)
(Rs 701.9**croreX.22X30/360)
Cost of long term funds invested in debtors:

*Amount of Advance=0.88X(Rs 875crore Rs 21.9 crore)= Rs 750.7crore

**Amount of Advance=0.84X(Rs 875crore Rs 39.4 crore)= Rs 701.9crore
(C) Indbank Factor Proposal

With recourse

Without recourse





[(Rs 875 crore-Rs721.8 crore)X0.15X30/360]


[(Rs 875 crore-Rs674.8 crore)X0.15X30/360]


Factoring Commission (Rs 875 croreX0.018)

(Rs 875 croreX0.036)
Discount charge(Rs 721.8croreX.20X30/360)
(Rs 674.8croreX.21X30/360)
Cost of long term funds invested in debtors:

Amount of Advance=0.84X(Rs 875crore Rs 15.7 crore)= Rs 721.8crore

Amount of Advance=0.80X(Rs 875crore Rs 31.5 crore)= Rs 674.8crore

Decision Analysis: Recourse Factoring

Benefits (Rs 57.2-Rs 12 Bad debts to be born by company)
Net Benefits


Decision Analysis: Non-Recourse Factoring
Benefits (Rs 57.2+Rs 1.1Bad debts to be borne by factor)





Net Benefits



Advice: My advice to the CFO of Sunlight Industries would be to accept the

proposal of Indbank Factors for recourse factoring.


Though factoring services have been introduced since 1991 in India still it is quite
new in the sense that factoring product is not widely known in many parts of the
country. Recognizing the utility of factoring services for small and medium size
industrial and commercial enterprises in India, for the first time the Vaghul
Committee which submitted its report on the Money Market, recommended the
development of a system of factoring of open account sales particularly for the
small scale industrial units. This committee further observed that both banks and
non-bank financial institutions in the private sector should be encouraged to set up
institutions for providing factoring services. Later, the Kalyanasundaram
Committee, which was appointed by the Reserve Bank of India (RBI) in 1988
specifically for exploring the possibilities of launching factoring services in India,
found an abundant scope for such services and hence strongly advocated for the
introduction of factoring services in India. This committee also observed that
banks were ideally suited for providing factoring services to the industries in the
economy. However, the said Committee
expressed the view that to begin with only four or five banks either individually or
jointly should be allowed on zonal basis to undertake factoring services. The
recommendations of Kalyanasundaram Committee were accepted by the RBI.
Subsequently a suitable amendment was made in the Banking Regulation Act
1949, so as to allow banks to set up subsidiary company for undertaking factoring
services. To begin with, the RBI permitted both the State Bank of India and Canara
Bank to start factoring services through their own subsidiaries. Accordingly, two
factoring companies in India, i.e. SBI Factors and Commercial Services Ltd. and
Canbank Factors Ltd; sponsored by the State Bank of India and Canara Bank

respectively, commenced operations in 1991. In the beginning they were allowed

to operate in Western and Southern Zone of India respectively. However, later on,
the RBI lifted these area restrictions on their operations and accordingly, both
these companies were given permission to expand and operate their business in
other parts of the country. In view of this, they can operate on all-India basis. In
1993 the RBI
allowed all the scheduled commercial banks to introduce factoring services either
departmentally or through a subsidiary set-up. Besides SBI Factors and
Commercial Services and Canbank Factors Ltd., there are a few non-banking
finance companies such as Formost Factors Ltd., Global Trade Finance Pvt. Ltd. (a
subsidiary of EXIM Bank) and Integrated Financial Services Ltd., which are also in
the business of domestic factoring in India. Of these, Global Trade Finance Pvt.
Ltd. and Formost Factors Ltd. have undertaken the business of export factoring
also. Besides these non-banking finance companies, Small Industries Development
Bank of India (SIDBI), Hongkong and Shanghai Banking Corporation have been
offering factoring services to their clients. Almost all of them have been providing
factoring services to the SSI and non-SSI units.

Factoring companies in India

Canbank Factors Limited:


SBI Factors and Commercial Services Pvt. Ltd:


The Hongkong and Shanghai Banking Corporation Ltd:

Foremost Factors Limited:


Global Trade Finance Limited:


Export Credit Guarantee Corporation of India Ltd:


Citibank NA, India:


Small Industries Development Bank of India (SIDBI):

Standard Chartered Bank:



Factoring is a money market instrument.
Since, factoring is not a negotiable instrument, customers consent is
required about the factoring arrangement under which he will make a
repayment directly to the factor but not to the client.
As a result of factoring services, the enterprise can concentrate on
manufacturing and selling.
The risk of bad debts is eliminated.
The factoring institution also provides advice on business trends and other
related matters.