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INTRODUCTION
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.
DEFINITION
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.
MECHANISM
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:
Customer
credit sale of
goods
Client
Invoice
Pays the
balance
amount
Submit invoice
copy
Payment up to
80% initially
Factor
FUNCTIONS
Purchase and collection of debt
Sales ledger management
Credit investigation and undertaking of credit risk
Provision of finance against debts
Rendering consulting services
TYPES OF FACTORING
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.
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
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).
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.
ADVANTAGES
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.
4)
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.
ii.
Advance, 88% and 84% for the recourse and non-recourse arrangement
respectively
iii.
Discount charge in advance 21% for recourse and 22% without recourse
iv.
ii.
iii.
Discount charge upfront, without recourse 21% and with recourse 20%
iv.
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.
FINANCIAL ANALYSIS OF RECEIVABLES MANAGEMENT ALTERNATIVES (Rs crore)
Rs 6.4
12.0
15.4
9.0
14.4
Total Cost
57.2
Without recourse
21.9
39.4
13.1
12.9
1.6
2.2
36.6
54.5
With recourse
Without recourse
15.7
31.5
12.0
11.8
1.9
2.5
29.6
45.8
Amount of Advance=0.84X(Rs 875crore Rs 15.7 crore)= Rs 721.8crore
36.6
8.6
Decision Analysis: Non-Recourse Factoring
Particulars
Canbank
Benefits (Rs 57.2+Rs 1.1Bad debts to be borne by factor)
58.3
Indbank
45.2
29.6
15.6
Indbank
58.3
Costs
54.5
45.8
Net Benefits
3.8
12.5
http://www.canbankfactors.com
http://www.sbifactors.com
http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services
Foremost Factors Limited:
http://www.foremostfactors.net
http://www.gtfindia.com
https://www.ecgc.in/Portal/productnservices/maturity/mfactoring.asp
http://www.citibank.co.in
http://www.sidbi.in/fac.asp
www.standardchartered.co.in
CONCLUSION
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.