Presented by : 1. Pravin Gavali 2.
Vickram Singh MIT-MBA (Finance)
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Recourse factoring: In recourse factoring, the factor purchases trade debts and essentially renders collection service and maintains sales ledgers. But in case of default or non payment by a trade debtor, the client refunds the amount to the factor. Hence it does not include bad debts protection. Non recourse factoring: Under this ,the factor s obligation to the client becomes absolute due date of the invoice, irrespective of the payment made or not made by the trade debtor. In the other words, if the trade debtor fails to make payment, the factor cant recover this amount from the client. In recourse factoring the charges are high as they offer the client protection against bad debts. The loss arising out of irrecoverable receivables is borne by the factor.
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3. Advance factoring: The factor pays a pre-specified portion ,ranging b/w 75% to 90% of the factored receivables in advance, the balance being paid upon collection on the guaranteed payment date. 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 invoices are accounted for. The client has to pay interest on the advance/repayment b/w the date of such payment and the date of actual collection from the customer /due guaranteed payment date of such payment and the date ,determined on the basis of prevailing short term rate. 4. Bank participation factoring: An extension of advance factoring is bank factoring under this a bank provides an advance to the client to finance a part ,say 50% of the factor reserve that is factored debt less advance given by the factor. Assuming 75% advance by the factor and 50%advance by the bank the factor and the bank b/w them make a pre payment of 87.5%of the debt and the client share is only 12.5%of the investment receivables.
5. Maturing factoring : 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. The guaranteed payment date is generally fixed taking into account the previous ledger expereince of the client and a period for slow collection after the due date. 6. Notified & undisclosed factoring: In case of notified and undisclosed factoring the customer informed about the assignment of the debt to the factoring agent and is also asked to pay the dues to the factor instead of the firm. On the other hand in undisclosed factoring the factoring arrangement is not disclosed to the customer but the customer is required to make the payment to the changed address.
7. Full factoring : this is the most comprehensive form of factoring combining the features of almost all the factoring service , specially those of non recourse and advance factoring. It is also known as Old line factoring . full factoring provides the entire spectrum of services namely collection, credit protection, sales ledger administration and short term finance. 8. Invoice factoring: strictly speaking this form of factoring is not considered as an integral part of the present day factoring system because it does not carry the service element of factoring. Under this type of factoring the debts due to the client are purchased by the factor thus provides improved liquidity under which the supplier position becomes very comfortable.
9. Buyer based, seller based and selective factoring: buyer based factoring means that a factor would maintain a list of buyers whose receivables would maintain a list of buyers whose receivables would be factored without recourse to the seller. Whereas in seller based factoring , the factor would prefer seller based factoring with recourse and without recourse. Seller based factoring is known as selective factoring where the seller is restricted to sell to the approved buyer. 10. Export factoring: this is also known as international factoring or cross border factoring. Export factoring houses deal with export sales and provide financial service, collection service, advisor service and service for completing legal formalities pertaining to export. It is quite helpful to small exporters.
1. Administration of sales ledger: the factor maintains the clients sales ledger. On transacting a sales deal an invoice is sent by the client to the customer and a copy of the same is sent to the factor. The ledger is generally maintained under the open item method in which each receipt is matched against the specific invoice. The customers account clearly reflects the various open invoices o/s on any given date. The factor also gives periodic reports to the client on the current status of receivables, receipts of payments from the customers and other useful information.
2. Provision of collection facility: the factor undertakes to collect the receivables on behalf of the client relieving him of the problems involved in collection and enables him to concentrate on other important functional areas of business. This also enables the client to reduce the cost of collection by way of savings in manpower, time and efforts. The use of trained manpower with sophisticated infrastructural backup enables a factor to systematically follow up and make timely demands on the debtors to make payments. Also the debtors are more responsive to9 the demands from a factor being a credit institution. Collection of receivables can be considered as the most important function of a factor.
3. Financing trade debts: the unique feature of factoring is that a factor purchases the book debts of his client at a price and the debts are assigned in favor of the factor who is willing to grant 85% of the assigned debts. The balance 15-20%is retained as a factor reserve. Where the debts are factored with recourse the finance provided would become refundable by the client in case of non payment by the buyer . However where the debts are factored with recourse the factors obligation to the seller becomes absolute on the due date of the invoice whether or not the buyer makes a payment.
4. Credit control and credit protection: assumption of credit risk is one of the important functions of a factor. This service is provided where the debts are factored without recourse. The factor in consultation with the client fixes credit limit for approved customers. Within these limits the factor undertakes to purchase all trade debts of a customer without a recourse. In other words the factor assumes the risk of default in payment by the customers. Arising from this function of the factor there are two important incidental benefits accruing to the client, first factoring relieves the client of the collection work, secondly with access to extensive information available on the financial standing and the credit rating of the individual customers and their track record of payments the factor is able to advise the client on the credit worthiness of the potential customer.
5. Advisory services: these services are spin offs of the close relationship b/w a factor and a client. By virtue of their specialized knowledge in finance and credit dealings and access to extensive credit information factors can provide a variety of incidental advisory services to their clients such as: A. customers perception of the clients products, changes in marketing strategies. B. audit of the procedures followed for invoicing, delivery and dealing with sales return.
There are two types of factoring charges : 1. Finance Charge 2. Service fee
Finance Charge : Finance charge is computed on the pre-payment O/s in the clients a/c at monthly intervals. Finance charges are only for financing that has been availed. This charges are similar to the interests levied on a cash credit facilities in a bank. 2. Service Fee : Service charge is a nominal charge levied at monthly intervals to cover the cost of services like collection, sales ledger mgmt., & periodical MIS reports. Service fee is determined on the basis of criteria such as the Gross sales values, the no. of customers, the no. of invoices & credit notes & the degree of credit risk represented by the customers or the transactions.
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Legal Aspect Of Factoring
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Upon entering into a factoring agreement, the client agrees to serve a notice of assignment in the prescribed form to all customers, whose receivables have been factored. The clients agrees to provide all copies of invoices, challans, and other evidences relating to the factored a/c & also remit payment received, if any, by him against the factored invoices. The factor requires a power of attorney to assign the debts and to draw negotiable instruments in respect of such debts.
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The legal status of the factor is that of an assignee. In case of multiple finance ( i.e., part of book debts are financed by bank and part by factoring), the letter of disclaimer is required by factor so that there is no duplicate charge & double financing is avoided. Factoring transactions attract stamp duty to assign all debts.
{ (law) a voluntary repudiation of a person's legal claim to something }
The Mechanism of factoring can be explained with the help of the following diagram :
Process of Factoring
Client 3 Payment up to 80% 6 Balance 20% On realization 4 Statement to customer Factor 5 Payment to factor Customer 1 Send invoice to customer
2 Assign invoice to factor
Mechanism Of Factoring
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Customer places an order with the client for goods &/or service on credit; client delivers the goods & sends invoice to customers. Client assigns invoice to factor. Factor makes pre-payment up to 80% & sends periodical statements. Monthly statement of accounts to customer & follow-up. Customer makes payment to factor. Factor makes balance 20% payment on realization to the client.
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Benefits to the Client The clients credit sales are immediately converted into ready cash as the factor makes a payment of around 80% of the factored invoices in advance. This proportion of finance is higher than the bank finance against credit sales. The client can offer competitive credit terms to his buyers which, in turn, enable him to increase his sales & profits. The cash realized from credit sales can be used to accelerate the production cycle.
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The client is free from the tensions of monitoring his sales ledger and can concentrate on production, marketing, & other aspects. This results in a reduction in overhead expenses & an increase in sales & profit. Factoring results in a close alteration among working capital components of the business. Efficient mgmt. of one component can have positive impact on other components. For example, an increase in liquidity enables the firm to avail of discounts on purchases of raw materials. The factor provides a comprehensive credit control system by analyzing payment history. This helps in assessing the quality of the debtors & monitoring their financial health. The client can expand his business by exploring new markets.
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Benefits to the Customers (Buyers): Factoring facilitates the credit purchases of the customers as they get adequate credit period. Customers save on bank charges & expenses. The customer has not to furnish any documents. He merely to acknowledge the notification letter, that is, an undertaking to make payment of the invoices to the factor. Customers are furnished with periodical statements of O/S invoices by the factor. Factoring does not impinge on the customers rights vis--vis the suppliers in respect of quality of goods, contractual obligations, & so on.
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Benefits to Banks :
Factoring improves liquidity of the clients & thereby, improves the quality of advances of banks. Factoring is not a threat to banking; it is a financial service complementary to that of the banks.
Costlier : Factoring could prove to be costlier to inhouse mgmt. of receivables; especially for large firms which have access to similar sources of funds as the factors themselves and which on account of their size have well organized credit & receivable mgmt. 2. Deleterious Effect on the Creditworthiness : Factoring is perceived as an expensive form of financing & also as finance of the last resort. This tends to have a deleterious effect on the creditworthiness of the company in the market.
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Credit Limits on Trade :
The factor will want to set credit limits for customers which may affect the way one trades. 4. Difficult to Exit the Agreement : Ending a factoring arrangement can be difficult where the only exit route is to repurchase the sales ledger or to switch factors & that could cause a sudden shortfall in ones working capital. 5. Reliance on Factor : In the case of factoring, one is reliant on the factor to collect the debt in a timely & efficient manner.
Factoring transactions in India are governed by the following Acts:Indian Contract Act, 1872 Sale of Goods Act, 1930 Transfer of Property Act, Banking Regulation Act, 1949 Foreign Exchange Regulation Act, 1977.
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