SWAYAM SIDDHI COLLEGE OF MGMT & RESEARCH
DEBTORS FINANCING-
FACTORING
By
PROF. CA UJWAL DHOKANIA
(M.Com, SET, CA, Phd Regd)
CONTENTS
MEANING
HOW DOES IT WORK?
BENEFITS
FEATURES
MECHANICS
VARIOUS TYPES
FACTORING VS FORFAITING
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 financial transaction and a type of debtor finance in which a
business sells its accounts receivable (i.e., invoices) to a third party (called
a factor) at a discount.
How Does it Works
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.”
The main reason that companies choose to factor is that they want to
receive cash quickly on their receivables, rather than waiting the 30 to 60
days it often takes a customer to pay. Factoring allows companies to quickly
build up their cash flow, which makes it easier for them to pay employees,
handle customer orders and add more business.
PROCESS
BENEFITS
Boosting cash flow is the main reason most companies factor. However,
factoring provides many other advantages as well. Here are a few of them:
Factors provide free back-office support, including managing collections from your customers. This gives you
more time and resources to focus on growing your company.
Factoring is based on the quality of your customers’ credit, not your own credit or business history.
Factoring can be customized and managed so that it provides necessary capital when your company needs it.
Factoring is not a loan, so you do not incur debt when you factor.
Factoring is scalable, meaning the amount of funding can grow as your receivables grow.
Features
Credit Cover:
The factor takes over the risk burden of the client and thereby the client’s credit is covered through advances.
Cash advances:
The factor makes cash advances to the client within 24 hours of receiving the documents.
Sales ledgering:
As many documents are exchanged, all details pertaining to the transaction auto matically computerized and stored.
Collection Service:
The factor, become the clients debts collection of cheques and other follow- upprocedures are done by the factor in
its own interest.
Provide Valuable advice:
The factors also provide valuable advice on country-wise and customer-wise risks. This is because the factor is in a
position to know the companies of its country better than the exporter clients
Mechanism
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
TYPES OF FACTORING SERVICES
1. Full Factoring
This is also known as "Without Recourse Factoring ". It is the most comprehensive type of
facility offering all types of services namely finance sales ledger administration, collection, debt
protection and customer information.
2. Recourse Factoring
The Factoring provides all types of facilities except debt protection. This type of service is
offered in India. As discussed earlier, under Recourse Factoring, the client's liability to Factor is
not discharged until the customer pays in full.
3. Maturity Factoring
It is also known as "Collection Factoring ". Under this arrangement, except providing finance,
all other basic characteristics of Factoring are present. The payment is effected to the client at the
end of collection period or the day of collecting accounts whichever is earlier.
TYPES OF FACTORING SERVICES
4. Advance Factoring:
This could be with or without recourse. Under this arrangement, the Factor provides advance at an agreed rate of interest to the client on
uncollected and non-due receivables. This is only a pre-payment and not an advance.
5. Invoice Discounting:
In this arrangement, the only facility provided by the Factor is finance. In this method the client is a reputed company who would like to
deal with its customers directly, including collection, and keep this Factoring arrangement confidential. The client collects payments
from customer and hands it over to Factor. The risk involved in invoice discounting is much higher than in any other methods.
6. Bulk Factoring:
It is a modified version of Involve discounting wherein notification of assignment of debts is given to the customers. However, the client
is subject to full recourse and he carries out his own administration and collection.
7. Agency Factoring:
Under this arrangement, the facilities of finance and protection against bad debts are provided by the Factor whereas the sales ledger
administration and collection of debts are carried out by the client.
FORFAITING
Forfaiting is a factoring arrangement used in
international trade finance by exporters who
wish to sell their receivables to a forfeiter.
FACTORING V/S FORFAITING
Factoring refers to a financial arrangement whereby the business sells its
trade receivables to the factor (bank) and receives the cash payment.
Forfaiting is a form of export financing in which the exporter sells the
claim of trade receivables to the forfeiter and gets an immediate cash
payment.
Factoring deals in the receivable that falls due within 90 days. On the other
hand, Forfaiting deals in the accounts receivables whose maturity ranges
from medium to long term.
Factoring involves the sale of receivables on ordinary goods.
Conversely, the sale of receivables on capital goods are made in
forfaiting.
Factoring provides 80-90% finance while forfaiting provides 100% financing of the
value of export.
Factoring can be recourse or non-recourse. On the other hand, forfaiting is always
non-recourse.
Factoring cost is incurred by the seller or client. Forfaiting cost is incurred by the
overseas buyer.
Forfaiting involves dealing with negotiable instruments like bills of exchange and
promissory note which is not in the case of Factoring.
In factoring, there is no secondary market, whereas in the forfaiting secondary market
exists, which increases the liquidity in forfaiting.
Practical Case Studies
Thank You
