Factoring is a financial transaction

where a firm sells its receivables to

a financial institution (factor). This
helps firms access quick cash flow,
Introduction while the factor assumes the
to Factoring responsibility of collecting the
debts.
=> Factoring involves the sale of a firm's
receivables (accounts receivable) to a factor
in exchange for cash. The factor takes
responsibility for the collection process.
 The word “Factor” has been derived from
the Latin word “Facere” which means “to make or
to do or to get things done”

Meaning Factoring may broadly be defined as the

relationship, created by an agreement, between
the seller of goods/services and a financial
institution called the factor, whereby the latter
purchases the receivables of the former and also
controls and administers the receivables of the
former.
Meaning
➢ The word “Factor” has been derived from
the Latin word “Facere” which means “to
make or to do or to get things done”
➢Factoring may broadly be defined as the
relationship, created by an agreement,
between the seller of goods/services and a
financial institution called the factor, whereby
the latter purchases the receivables of the
former and also controls and administers the
receivables of the former.
Who is factor?

Factor assumes the risk of

Factor is a financial collection of receivables and
institution that specializes in on the event of non payment
purchasing receivables from by debtors/customers bears
business firms. the risk of bad debt and
losses
The study group appointed by International
Institute for the Unification of Private Law
(UNIDROIT), Rome during 1988
recommended, in simple words, the
definition of factoring as under:
“Factoring means an arrangement between
a factor and his client which includes at least
two of the following services to be provided
by the factor:
▪ Finance
▪ Maintenance of accounts
▪ Collection of debts
▪ Protection against credit risks”.
Concept
FACTOR

Factoring is a specialized activity

whereby a firm converts its
receivable into cash by selling them
to a factoring organization.
CLIENT CUSTOMER
Client (Manufacturers):- Client is the person who
wants to sell the commodity to the customer.

Customer (Merchandisers) :- Customer is the person

who wants that commodity but he do not have
sufficient money.

Factor :- Factor enters into agreement with the

client for rendering factor services to it. The factor
receives payment from the buyer on due dates and
remits the money to seller after usual deductions.
The mechanism of factoring is summed up as below:
i. An agreement is entered into between the selling firm and
the firm. The agreement provides the basis and the scope
understanding reached between the two for rendering
factor service.
ii. The sales documents should contain the instructions to
make payment directly to the factor who is assigned the
job of collection of receivables.
iii. When the payment is received by the factor, the account
of the firm is credited by the factor after deducting its
fees, charges, interest etc. as agreed.
iv. The factor may provide advance finance to the selling
firm conditions of the agreement so require.
 TYPES OF FACTORING

Recourse and Advance and Conventional Domestic and

Non-recourse Maturity or Full Export
Factoring Factoring Factoring Factoring

Selected Selected Disclosed and

Limited
Seller Based Buyer Based Undisclosed
Factoring
Factoring Factoring Factoring
A multinational company has factored its accounts receivable
of $20,000 due in one month. The factor advances 75 percent
of the receivables, charges 1.5 percent per month, and 2
percent commission. Both the interest and the commission are
paid on a discount basis.

Solution: Face value $20,000

Less: 25% reserve due from factor 5,000
2% commission 400
Funds available for advance $14,600
Less: 1.5% interest on advance 219
Net proceeds from advance $14,381
 In a recourse factoring arrangement, the
factor has recourse to the client (selling
firm) if the receivables purchased turn out
Recourse to be bad, then the risk of bad debts is to
and Non- be borne by the client and the factor does
not assume credit risks associated with the
recourse receivables. Thus the factor acts as an
agent for collection of bills and does not
Factoring cover the risk of customer’s failure to pay
debt or interest on it.
Whereas, in case of non-recourse factoring, the risk or loss on account
of non-payment by the customers of the client is to be borne by the
factor and he cannot claim this amount from the selling firm. Since the
factor bears the risk of non-payment, commission or fees charged for
the services in case of nonrecourse factoring is higher than under the
recourse factoring.

The additional fee charged by the factor for bearing the risk of bad
debts/non-payment on maturity is called del credere commission.
Advance and Maturity Factoring
Under advance factoring arrangement, the factor pays only a certain
percentage (between 75 % to 90 %) of the receivables in advance to
the client, the balance being paid on the guaranteed payment date. As
soon as factored receivables are approved, the advance amount is
made available to the client by the factor. The Factor charges
discount/interest on the advance payment from the date of such
payment to the date of actual collection of receivables by the factor.
In case of maturity factoring, no
advance is paid to client and the
payment is made to the client only on
collection of receivables or the
guaranteed payment data as the case
may be agreed between the parties.
Thus, maturity factoring consists of
the sale of accounts receivables to a
factor with no payment of advance
funds at the time of sale.
Domestic and Export
Factoring
The basic difference between the domestic and
export factoring is on account of the number of
parties involved.
In the domestic factoring three parties are
involved, namely:
▪ Customer (buyer)
▪ Client (seller)
▪ Factor (financial intermediary)

All the three parties reside in the same country.

Conventional or Full
Factoring
Under this system the factor performs
almost all services of collection of
receivables, maintenance of sales ledger,
credit collection, credit control and credit
insurance. The factor also fixes up a draw
limit based on the bills outstanding maturity
wise and takes the corresponding risk of
default or credit risk and the factor will have
claims on the debtor as also the client
creditor. It is also known as Old Line
Factoring.
Export factoring is also termed as cross-
border/international factoring and is almost similar to
domestic factoring except that there are four parties to
the factoring transaction. Namely, the exporter (selling
firm or client), the importer or the customer, the export
factor and the import factor.
Since, two factors are involved in the export Factoring, it is
also called two-factor system of factoring.
Two factor system results in two separate but inter-
related contracts:
1. between the exporter (client) and the export factor.
2. Export factor and import factor.
▪ The import factor acts as a link between export factor and
the importer, helps in solving the problem of legal
formalities and of language.
▪ He also assumes customer trade credit risk, and agrees to
collect receivables and transfer funds to the export factor
in the currency of the invoice.
▪ Export/International factoring provides a non-recourse
factoring deal.
▪ The exporter has 100 % protection against bad debts loss
arising on account of credit sales.
 Limited Factoring

Under limited factoring, the factor discounts only

certain invoices on selective basis and converts credit
bills into cash in respect of those bills only.
Selected Seller Based Factoring
▪ The seller sells all his accounts receivables to the factor
along with invoice delivery challans, contracts etc. after
invoicing the customers.
▪ The factor performs all functions of maintaining the
accounts, collecting the debts, sending reminders to the
buyers and does all consequential and incidental functions
for the seller.
▪ The sellers are normally approved by the factor before
entering into factoring agreement
 Selected Buyer Based Factoring
▪ The factor first of all selects the buyers on the basis of their
goodwill and creditworthiness and prepares an approved
list of them.
▪ The approved buyers of a company approach the factor for
discounting their purchases of bills receivables drawn in
the favor of the company in question (i.e. seller).
▪ The factor discounts the bills without recourse to seller
and makes the payment to the seller.
Disclosed and Undisclosed
Factoring
• In disclosed factoring, the name of the factor is mentioned
in the invoice by the supplier telling the buyer to make
payment to the factor on due date.
• However, the supplier may continue to bear the risk of bad
debts (i.e. non-payments) without passing to the factor.
• The factor assumes the risk only under nonrecourse
Factoring agreements.
• Generally, the factor lays down a limit within which it will
work as non-recourse. Beyond this limit the dealings are
done on recourse basis i.e. the seller bears the risk.
• Under undisclosed factoring, the name of the factor is
not disclosed in the invoice.

• But still the control lies with the factor. The factor
maintain sales ledger of the seller of goods, provides
short-term finance against the sales invoices but the
entire transactions take place in the name of the
supplier company (seller).
FUNCTIONS OF FACTORING
The purchase of book debts or receivables is central to
the function of factoring permitting the factor to
provide basic services such as:
1. Administration of sellers’ sales ledger.
2. Collection of receivables purchased.
3. Provision of finance.
4. Protection against risk of bad debts/credit control
and credit protection.
5. Rendering advisory services by virtue of their
experience in financial dealings with customers.
1. Administration of Sales Ledger

✓The factor assumes the entire responsibility of

administering sales ledger.
✓The factor maintains sales ledger in respect of each
client.
✓When the sales transaction takes place, an invoice is
prepared in duplicate by the client, one copy is given to
customer and second copy is sent to the factor.
 2. Collection of Receivables
▪ The factor helps the client in adopting better credit control
policy.
▪ The main function of a factor is to collect the receivables on
behalf of the client and to relieve him from all the botherations/
problems associated with the collection.
▪ This way the client can concentrate on other major areas of his
business on one hand and reduce the cost of collection by way
of savings in labor, time and efforts on the other hand.
▪ The factor possesses trained and experienced personnel,
sophisticated infrastructure and improved technology which
help him to make timely demands on the debtors to make
payments.
 3. Provision of Finance
▪ Finance, which is the lifeblood of a business, is made
available easily by the factor to the client.
▪ A factor purchases the book debts of his client and debts are
assigned in favor of the factor. 75% to 80 % of the assigned
debts is given as an advance to the client by the factor.
✓ Where an agreement is entered into between the client
(seller) and the factor for the purchase of receivables
without recourse, the factor becomes responsible to the
seller on the due date of the invoice whether or not the
buyer makes the payment to the factor.
✓ Where the debts are factored with recourse- the client has
to refund the full finance amount provided by the factor in
case the buyer fails to make the payment on due date.
 4. Protection Against Risk
• This service is provided where the debts are factored
without recourse.
• The factor fixes the credit limits (i.e. the limit up to which
the client can sell goods to customers) in respect of
approved customers.
• Within these limits the factor undertakes to purchase all
trade debts and assumes risk of default in payment by the
customers.
▪ The factor not only relieves the client from the collection
work but also advises the client on the creditworthiness of
potential customers.
▪ Thus the factor helps the client in adopting better credit
control policy.
▪ The credit standing of the customer is assessed by the
factors on the basis of information collected from credit
rating reports, bank reports, trade reference, and financial
statement analysis and by calculating the important ratios
in respect of liquidity and profitability position.
 5. Advisory Services
These services arise out of the close relationship between a
factor and a client. Since the factors have better knowledge
and wide experience in field of finance, and possess
extensive credit information about customer’s standing,
they provide various advisory services on the matters
relating to:
➢ Customer’s preferences regarding the client’s products.
➢ Changes in marketing policies/strategies of the
competitors.
➢ Suggest improvements in the procedures adopted for
invoicing, delivery and sales return.
➢ Helping the client for raising finance from banks/financial
institutions, etc.
 Evaluation Framework
The evaluation framework should be on a consideration of the relative
costs and benefits associated with the two alternatives to receivables
management. They are:

In-house management
by the firm.

Factoring services
(recourse or non-
recourse)
Cost Associated With In- House Management

• Cash Discount
• Cost of funds invested in receivables
• Bad – Debts
• Lost contribution on forgone sales
• Avoidable costs of sales ledger administration and credit
monitoring.

Cost Associated With Recourse Or Non - Recourse

Factoring
• Factoring commission
• Discount charge
• Cost of long- term funds invested in receivables.
 Benefits
• Cash Discount
Associated • Cost of funds invested in receivables
With • Lost contribution on forgone sales
• Avoidable costs of sales ledger
Recourse administration and credit monitoring.
Factoring

Benefits • Cash Discount

Associated • Cost of funds invested in receivables
• Bad – Debts
With Non - • Lost contribution on forgone sales
Recourse • Avoidable costs of sales ledger
administration and credit monitoring.
Factoring
Advantages of Factoring:
Increases working capital

Avoid additional liabilities

Improves credit monitoring

Reduces administrative cost

Reduce supplier credit costs

Protection against bad-debts in case of non-recourse

Better management of the organization

Disadvantages of Factoring:

Cost

Possible harm to
customer relation

Company image
distortion
 Legal aspects of factoring

In vietnam, please see circular 20/2024/TT-NHNN

dated 28 June 2024