FACTORING SERVICES

MASTER OF COMMERCE IN BANKING AND FINANCE SEMESTER-2 (2012-2013)

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD OF DEGREE OF MASTER OF COMMERCE BANKING AND FINANCE

SUBMITTED BY MR. JAYESH D. KOLI ROLL NO. 2028

UNDER THE GUIDANCE OF ARTHI KALYANRAMAN

M.D.COLLEGE OF ARTS, SCIENCE & COMMERCE DR. S.S. RAO ROAD, PAREL, MUMBAI - 400 012.

CERTIFICATE

This is to certify that Mr. Jayesh D. Koli of M.Com Banking And Finance Semester-2 (2012-2013) has successfully completed project on Factoring Services under the guidance of Arthi Kalyanraman.

Course Co-ordinator

Principal

Internal Examiner

External Examiner

DECLARATION

I Mr. Jayesh D. Koli student of Master Of Commerce Banking And Finance Semester-2 (2012-2013) hereby declares that I have completed the project on Factoring Services. The information submitted is true and original to the best of my knowledge.

Jayesh D. Koli Roll No.

Acknowledgement

I owe a great many thanks to a great many peoples who helped me and supported me during the writing of this book. My deepest thanks to Lecturer, Arthi Kalyanraman. The guide of the project for guiding and correcting various documents of mine with attention and care.

She has taken pain to go through the project and make necessary correction as and when needed.

I express my thanks to the principle of Maharshi Dayanand College, Parel for extending his support.

I would also thanks my institution and my faculty members without whom this project would have been a distant reality. I also extended my heartfelt thanks to my family and well wishers.

JAYESH D. KOLI

Index & Content

Objectives________________________________________________________1 What is factoring?__________________________________________________2 The History of Factoring___________________________________________3-4 Characteristics of factoring_________________________________________5-6 Different types of Factoring________________________________________7-8 Factoring companies in India_________________________________________9 Domestic Factoring & International Factoring________________________10-13 Function of a factor_____________________________________________14-16 Advantages of factoring services_____________________________________17 Disadvantages of factoring services___________________________________18 Forfaiting, methodology____________________________________________19 Mechanism____________________________________________________20-21 Documentation and cost____________________________________________22 DIFFERENCE BETWEEN FACTORING AND FORFAITING_________23-25 Case study of EXIM Bank________________________________________26-29 Conclusion_______________________________________________________30 Bibliography______________________________________________________31

Objective

The objective of this project is to study and understand the:

Factoring services in India.

What is the advantages and disadvantages of factoring. Difference between factoring and Forfaiting. How Exim bank provide factoring services.

What is factoring?

Factoring is a financial option for the management of receivables. In simple definition it is the conversion of credit sales into cash. In factoring, a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80%(rarely up to90%) of the amount immediately on agreement. Factoring company pays the remaining amount (Balance 20%finance cost-operating cost) to the client when the customer pays the debt. Collection of debt from the customer is done either by the factor or the client depending upon the type of factoring. We will see different types of factoring in this article. The account receivable in factoring can either be for a product or service. Examples are factoring against goods purchased, factoring for construction services (usually for government contracts where the government body is capable of paying back the debt in the stipulated period of factoring. Contractors submit invoices to get cash instantly), factoring against medical insurance etc. Let us see how factoring is done against an invoice of goods purchased.

The History of Factoring

In this article we will review the history of factoring as well as the pros and cons of factoring. Almost since the dawn of civilization, there has been factoring. Factoring is a way of advancing funds for expected payment. In the earliest times of civilization, 4,000 years ago, the Mesopotamians used factoring in their business dealings. However, factoring was not terribly regular. The ancient Romans used a form of factoring by selling promissory notes on a secondary market at a discount. Factoring gained true popularity, however, in trade between the American colonists and their European buyers. Prior to the American Revolution, merchants in the colonies sent raw materials, from timber to wool to cotton to furs, to British and European merchants. However, sending the goods such long distances could get expensive. And in the meanwhile, waiting for payment to come back across the Atlantic from Britain and Europe could cause delays in being able to do what was necessary to harvest and plant and process new orders. In order to get around these problems, the British and European merchants paid the colonists in part for the materials. This way, the colonists had an advance with which to continue their operations. These eased cash flow and created a streamlined process for ensuring that trade continued unabated. As society progressed after the American Revolution, and as the Industrial Revolution came, the focus of factoring changed. Credit became more important to factoring. The credit of the company itself was not as important as the credit of its clients. Indeed, in many cases, factors helped companies figure out which of its customers were the most credit worthy. This way, factors could also help companies keep their cash flow moving. They advanced companies capital based on what was owed them by their credit worthy customers. Before the 1930s, the

most popular industries for factoring were the garment and textile industries. These are industries that rely on raw materials. In order to make sure that companies could continue to buy raw materials to produce clothing and textiles, factoring was used. However, it soon became evident, after World War II, that factoring could work effectively for any business that invoiced others. During the 1960s, 1970s and 1980s, interest rates were on the rise and banks were increasingly regulated. This made it difficult for companies to get traditional financing. Factoring became even more popular, since it did not require the same sort of credit checks. Additionally, since the invoices were bought minus a fee it was possible to avoid the same sort of interest charges. Small business, startups and rapidly growing businesses benefitted especially from this increase in factoring. Factoring grew as a service as businesspeople found their options contracting.

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. Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement.

5. Factoring is a method of off balance sheet financing. 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% to3% per month depending upon the financial strength of the clients customer.

6. Indian firms offer factoring for invoices as low as 1000RsFor 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).

Different types of Factoring

A single factoring company may not offer all these services

Disclosed
In disclosed factoring client's customers are notified of the factoring agreement. Disclosed type can either be recourse or nonrecourse.

Undisclosed
In undisclosed factoring, client's customers are not notified of the factoring arrangement. Sales ledger administration and collection of debts are undertaken by the client himself. Client has to pay the amount to the factor irrespective of whether customer has paid or not. But in disclosed type factor may or may not be responsible for the collection of debts depending on whether it is recourse or nonrecourse.

Recourse factoring
In recourse factoring, client undertakes to collect the debts from the customer. If the customer don't pay the amount on maturity, factor will recover the amount from the client. This is the most common type of factoring. Recourse factoring is offered at a lower interest rate since the risk by the factor is low. Balance amount is paid to client when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts from the customer. Balance amount is paid to client at the end of the credit period or when the customer pays the factor whichever comes first. The advantage of non recourse factoring is that continuous factoring will eliminate the need for credit and collection departments in the organization.

Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com

SBI Factors and Commercial Services Pvt. Ltd: http://www.sbifactors.com

The Hongkong and Shanghai Banking corporation Limited: http://www.hsbc.co.in/in/corp/factserv.htm

Foremost Factors Limited: http://www.foremostfactors.net

Global Trade Finance Limited: http://www.gtfindia.com

Export Credit Guarantee Corporation of India Ltd: http://www.ecgcindia.com

Citibank NA, India: http://www.citibank.co.in

Small Industries Development Bank of India (SIDBI): http://www.sidbi.in/fac.asp

Domestic Factoring & International Factoring

Factoring is a service that covers the financing and collection of account receivables in domestic and international trade. It is an ongoing arrangement between the client and Factor, where invoices raised on open account sales of goods and services are regularly assigned to "the Factor" for financing, collection and sales ledger administration. The buyer and the seller usually have long term relationships. The client sells invoiced receivables at discount to the factor to raise finance for working capital requirement. The factor may or may not accept the incumbent credit risk. Factoring enables companies to sell their outstanding book debts for cash. The factor operates by buying from the selling company their invoiced debts. These are purchased, usually with credit protection, by the factor who then will be responsible for all credit control, collection and sales accounting work. Thus the management of the company may concentrate on production and sales and need not concern itself with non-profitable control and sales accounting matters. By obtaining payment of the invoices immediately from the factor, usually up to 80% of their value the company's cash flow is improved. The factor charges service fees that vary with interstates in force in the money market.

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HSBC currently offers both domestic and international factoring products. HSBC provides
finance solutions for all your sales and purchase requirements on the domestic front, and various export-factoring product services on the international level. Our factoring services offer a comprehensive receivables and payables management solution which includes transaction financing, credit protection, sales ledger administration and payment collection. At HSBC, our ability to be the comprehensive provider of Trade Solutions makes us a leading player in the Trade & Factoring market in India. We have dedicated Relationship Managers to provide any assistance that you may require with respect to your business and your trade needs.

Domestic Factoring
Through this product, our intention is to be an active partner in the management of your company's supply/delivery chain. Through domestic factoring, we could look at financing your receivables from your buyers. Additionally we also undertake to finance your vendor/supplier payments. Receivables Finance can be structured with on a With Recourse Basis (where we would be setting up lines on your company) or one Without Recourse Basis. Payments of all your service and utility bills could be done throughout Vendor Finance product. These could include for example, courier payments, electricity bills payment. Through this mechanism we will pay out your service provider on the due date of the invoice/bill and collect the money from you after a pre-determined credit period.

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International Factoring
In international factoring there are usually two factors. The export factor looks at financing the exporter and sales administration (presenting invoices at the right time, collecting payments being the key tasks). The import factor is interested in evaluating the buyer, collecting the money on time at the same time ensuring that he is protected against default. International factoring encompasses all the four services, that is, pre-payments, sales ledger administration, credit protection and collections.

Guide to International Factoring :

1. The importer places the order for purchase of goods with the exporter. 2. The exporter requests the Export Factor for limit approval on the importer. Export Factor in 3. Turn forwards this request to an Import Factor in the Importers country. The Import Factor 4. Evaluates the Importer and conveys its approval to the Export Factor who in turn conveys 5. Commencement of the Factoring arrangement to the Exporter. 6. The exporter delivers the goods to the importer. 7. Exporter produces the documents to the Export Factor. 8. The Export Factor disburses funds to the Exporter up to the prepayment amount decided and at the 9. Same time the forwards the documents to the Import factor and the Importer. 10. On the due date of the invoice, the Importer pays the Import Factor, who in turn remits this

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11. Payment to the Export Factor. 12. The Export Factor applies the received funds to the outstanding amount of the advance against 13. The invoice. The exporter receives the balance payment.

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Function of a factor

1. Administration of sales ledger The factor maintain sales ledger in respect of each client when the sales transaction takes place an invoice is prepared in duplicate by the client, O n e c o p y i s g i v e n t o customer and second copy is sent to the factor. Entries are made in the ledger on open item method. Each receipt is matched against the specific i n v o i c e . O n a n y g i v e n d a t e t h e c u s t o m e r account indicate the various open invoices outstanding .Periodic reports a r e s e n t b y f a c t o r t o t h e c l i e n t w i t h r e s p e c t t o c u r r e n t s t a t u s o f transaction, the periodicity of r e p o r t i s d e c i d e d . T h u s t h e e n t i r e s a l e s ledger administration responsibility of the client gets transferred to factor.

2 . Co l l e c t i o n o f R e c e i v a b l e s The main function of the factor is to collect the receivable on the behalf o f t h e c l i e n t a n d t o r e l i e v e h i m f r o m a l l t h e b o t h e r a t i o n s p r o b l e m s associated with the collection. This way the Clint can concentrate other major areas of his b u s i n e s s o n o n e h a n d a n d r e d u c e t h e c o s t o f collection by way of saving in labour time and efforts on the other hand. T h e f a c t o r p o s s e s s e s t r a i n e d a n d e x p e r i e n c e d p e r s o n a l , s o p h i s t i c a t e d infrastructure and improve technology which helps him to make timely demands on the debtors to make payments.

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3 . P r o v i s i o n o f Fi n a n c e Finance which is the life blood of a business, is made available easily byte factor to the client. A factor purchased 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 advance to the client by the factor.

4 . P r o t e c t i o n Ag a i n s t Ri s k This service is provided where the debts are factored without resources. The factor fixes the credit limit in respect of approved customers. Within this limit the factor undertakes to purchase all trade debts and assumes risk of default in payment by the customers. The factor not only relives t h e c l i e n t f r o m t h e c o l l e c t i o n w o r k b u t a l s o a d v i s e s t h e c l i e n t o n t h e creditworthiness of potential customers. Thus the factor helps the client i n a d o p t i n g b e t t e r c r e d i t c o n t r o l p o l i c y . T h e c r e d i t s t a n d i n g o f t h e customers is assessed by the factors on the basis of information collected from credit rating reports, bank reports, trade reference, financial statement analysis and by calculating the important ratios in respect of liquidity and proximity position. 5. Advisory Services These services arise out of the close relationship between a factor and a client. Since the factor have better knowledge and wide experience in f i e l d o f finance, and possess extensive credit information about customers standing they provide various advisory services on the matters relating to:

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Customers preferences regarding the clients products. Changes in marketing polices of the competitors. Suggest improvements in the procedures adopted for invoicing, delivery and sales return. I V . H e l p i n g t h e c l i e n t s f o r r a i s i n g f i n a n c e f r o m b a n k s / f i n a n c i a l institutions, etc.

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Advantages of factoring services

Under the factoring arrangement the client receives payment up to 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 manner. If the client avails the services of the factor in respect of sales ledger administration and collection of receivables, he need not have any administration set up for this purpose. Naturally this will result into a substantial savings in time and cost of maintaining own sales ledger administration and collecting receivables from the customer. Thus, it will reduce administrative cost and time. When without resource factoring arrangement is made, the client can eliminate the loss 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 virtual 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 rapidly provide information regarding product design/mix, prices, market conditions etc., the client which would could be useful to him for business decisions. The above mentioned benefits will accrue to the client provided the develops a better business relationship with the factor and both of them have mutual trust in each other.

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Disadvantages of factoring services

Image of the client may suffer as engaging a factoring agency is not consider a good sign of efficient management.

Factoring may not be of much use where companies or agents have on time sales with the customers.

Factoring increases cost of finance and of running the business. If the client has cheaper means of finance and credit (where goods are sold against advance payment), factoring may not useful.

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Forfaiting
The forfaiting owes its origin to a French term forfait which means to forfeit (or surrender) ones rights on something to some one else. Under this mode of export finance, then exporter forfaits his rights to the future receivables and the forfaiter loses recourse to the exporter in the event of non-payment by the importer.

Methodology
It is a trade finance extended by a forfaiter to an exporter/seller for an export/sale transaction involving deferred payment terms over a long period at a firm rate of discount. Forfaiting is generally extended for export of capital goods, commodities and services where the importer insists on supplies on credit terms. The exporter has recourse to forfaiting usually in cases where the credit is extended for long durations but there is no prohibition for extending the facility where the credits are maturing in periods less than one year. A credit for commodities or consumer goods is generally for shorter duration within one year. Forfaiting services are extended in such cases as well.

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Mechanism
There are five parties in a transaction of forfaiting. These are :
1. Exporter 2. Exporters bank 3. Importer 4. Importers bank and 5. Forfaiter

The exporter and importer negotiate the proposed export sale contract. These are the preliminary discussions.

Based on these discussions the exporter approaches the forfaiter to ascertain the terms for forfeiting.

The forfaiter collects from exporter all the relevant details of the proposed transaction, viz., details about the importer, supply and credit terms, documentation, etc., in order to ascertain the country risk and credit risk involved in the transaction..

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Depending upon the nature and extent of these risks the forfaiter quotes the discount rate. The exporter has now to take care that the discount rate is reasonable and would be acceptable to his buyer.

He will then quote a contract price to the overseas buyer by loading the discount rate, commitment fee, etc., on the sale price of the goods to be exported.

If the deals go through, the exporter and forfaiter sign a contract. Export takes place against documents guaranteed by the importers bank. The exporter discounts the bill with the forfaiter and the forfaiter presents the same to the importer for payment on due date or even can sell it in secondary market.

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Documentation and cost

Forfaiting transaction is usually covered either by a promissory note or bill of exchange. In either case it has to be guaranteed by a bank or, bill of exchange may be avalled by the importer bank.

The Aval is an endorsement made on bill of exchange or promissory note by the guaranteeing bank by writing per aval on these documents under proper authentication.

The forfeiting cost for a transaction will be in the form of commitment fee, discount fee and documentation fee.

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DIFFERENCE BETWEEN FACTORING AND FORFAITING Factoring Forfaiting

1. Suitable for ongoing open account sales, not backed by LC or accepted bills or exchanges. 2. usually provides financing for Short-term credit period of upto 180 days.

1. Oriented towards single transaction backed by LC or bank gurantee.

2. Financing is usually for medium to long-term credit periods from 180 days up to 7 tears through short-term credit of 30-180 days is also available for long transaction.

3. requires a continuous arrangements between factor and client, whereby all sales are

3. Seller need not route or commit other business to the forfeiter. Deals are concluded transaction wise.

routed through the factor 4. factor assumes responsibility For collection, helps client to reduce his own overheads. 4. Forfeiters responsibility extend to collection of forfeited debt only. Existing financing lines remains unaffected.

5. Separate charges are applied for financing, collection, administration, credit protection and provision of information.

5. Single discount charges is applied which depend on guarantying bank and country risk, credit period involved and currency of debt.

6. Services is available for Domestic and export receivables

6. Usually available for export receivables only denominated In any freely convertible currency.

7. Financing can be with or without recourse; the credit protection collection and administration services may also be Provided without financing 8. Usually no restriction on minimum Size of transactions that can be covered by forfeiting. 9. Factor can assist with completing import formalities in the buyers country and provide ongoing contract with buyers.

7. It is always without recourse and essentially a financing product.

8. Transaction should be of a minimum value of USD 250,000. 9. Forfeiting will accept only clean documentation in conformity with all regulations in the exporting /importing countries.

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Case study of EXIM Bank Description

Government of India launched the institution with a mandate, not just to enhance exports from India, but to integrate the countrys foreign trade and investment with the overall economic growth. Since its inception, Exim Bank of India has been both a catalyst and a key player in the promotion of cross border trade and investment. Commencing operations as a purveyor of export credit, like other Export Credit Agencies in the world, Exim Bank of India has, over the period, evolved into an institution that plays a major role in partnering Indian industries, particularly the Small and Medium Enterprises, in their globalization efforts, through a wide range of products and services offered at all stages of the business cycle, starting from import of technology and export product development to export production, export marketing pre-shipment and postshipment and overseas investment.

Organization

Exim Bank is managed by a Board of Directors, which has representatives from the Government, Reserve Bank of India, Export Credit Guarantee Corporation of India, a financial institution, public sector banks, and the business community.

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The Bank's functions are segmented into several operating groups including:

Corporate Banking Group which handles a variety of financing programmes for Export Oriented Units (EOUs), Importers, and overseas investment by Indian companies.

Project Finance / Trade Finance Group handles the entire range of export credit services such as supplier's credit, pre-shipment Agri Business Group, to spearhead the initiative to promote and support Agri-exports. The Group handles projects and export transactions in the agricultural sector for financing.

Small and Medium Enterprise: The group handles credit proposals from SMEs under various lending programmes of the Bank.

Export Services Group offers variety of advisory and value-added information services aimed at investment promotion.

Export Marketing Services Bank offers assistance to Indian companies, to enable them establish their products in overseas markets. The idea behind this service is to promote Indian export. Export Marketing Services covers wide range of export oriented companies and organizations. EMS group also covers Project exports and Export of Services.

Besides these, the Support Services groups, which include: Research & Planning, Corporate Finance, Loan Recovery, Internal Audit, Management Information Services, Information Technology, Legal, Human Resources Management and Corporate Affairs.

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Mechanism of EXIM Bank

Export-Import Bank of India, (EXIM Bank) has started with a scheme to the Indian exporters by working out an intermediary between the exporter and the forfaiter.

The scheme takes place in the following stages:

1. Negotiations being between exporter and importer with regard to contract price, period of credit, rate of interest, etc. 2. Exporter approaches EXIM Bank with all the relevant details for an indicative discount quote. 3. EXIM Bank approaches an overseas forfaiter, obtain the quote and gets back to exporter with the offer. 4. Exporter and importer finalise the term of contract. All costs levied by a forfaiter are to be transferred to the overseas buyer. As such discount and other charges are loaded in the basic contract value.

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5. Exporter approaches EXIM Bank and it in turn the forfaiter for the firm quote. The exporter confirms the acceptance of the arrangement. 6. Export takes place shipping documents along with bill of exchange, promissory note have to be in the prescribed format.

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Conclusion

Factoring is a money market instrument. Since, factoring is not negotiable instrument; customers consent is required about the factoring arrangement under which he will make a repayment directly to the factor bout not to the client.

As a result of factoring services, the enterprises 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.

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Bibliography
S. Parveen author of Financial Services M. com part-1 Wikipedia Scribed. Com Google

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