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FACTORING

Factoring basically involves transfer of the collection of receivables and the related bookkeeping functions from the firm to a financial intermediary called the factor. In addition, the factor often extends a line of credit against the receivables of the firm Thus, factoring provides the firm with a source of financing its receivables and facilitates the process of collecting the receivables. Factoring is of a recent origin in the India context. In 1988, the RBI constituted a High Powered Committee to examine the scope for offering factoring services in the country. In 1989, committee submitted its report strongly recommending the case for setting factoring subsidiaries.

FACTORING
Following the announcement of the guidelines, the SBI and Canara Bank have set-up their factoring subsidiaries, that is, SBI Factors and commercial services Ltd Canbank Factors Ltd. SBI Factors and Commercial Services Ltd has as market share of 40%. Canbank Factors Ltd is the leading player in this business with a market share of 55% CONCEPT OF FACTORING Factoring can be defined as the sale of book debts by a firm (referred to, as client) to a financial intermediary called the factor on the understanding that the factor will pay for the debts as and when they are collected or on a guaranteed payment date.

FACTORING
Usually the factor makes as part-payment immediately after the debts are purchased thereby providing immediate liquidity to the client. PROCESS OF FACTORING Client concludes a credit sale with the customer. Client sells the customers account to the factor and notifies the customer. Factor makes a part-payment (advance) against the account purchased after adjusting for commission and interest on the advance. Factor maintains the customers account and follows up for payment. Customer remits the amount due to the factor. Factor makes the final payment to the client when the account is collected or on a guaranteed payment date.

FACTORING
For rendering the services of collection and maintenance of sales ledger, the factor charges commission expressed as flat percentage of the value of debts purchased and collects this commission upfront.( at the time of purchasing the debt) For making an immediate part-payment against the debts purchased (which is of course an advance), the factor charges interest at as rate which is marginally higher than the ROI charged by the banks on WC advance. The interest charged is calculated for the period between the date of advance payment and the date of collection or the guaranteed payment date. If the interest charge is collected up-front, it is referred to as the discount charge.

EXAMPLE OF FACTORING
Under an advance factoring arrangement Bharat Factors Ltd has agreed to advance a sum of Rs 14 lacs against the receivables purchased from ABC Ltd. The agreement provides for an advance payment of 80% of the value of factored receivables and for guaranteed payment after three months from the date of purchasing the receivables. The advance carries a rate of interest 16% p.a. compounded quarterly and factoring commission is 105% of the value of factored receivables. Both interest and commission are collected up-front. Compute the amount actually made available to ABC Ltd. Calculate the effective cost of funds made available to ABC Ltd. Assume that the int. is collected in arrear and the commission is collected in advance. Calculate the effective cost of funds made available to ABC ltd.

EXAMPLE OF FACTORING
17.50 14.00 0.26 13.74 Less discount charges(140.1690/360) 0.56 Funds made available to ABC ltd. 13.18 B: Discount charges expressed as a %age of funds made available to ABC Ltd= 0.56100/13.18=4.25% The effective ROI is 4.25% per quarter Annualized ROI =[(1.0425)power raised to 41)]100=18.11% A: Value of factored receivable( =14/0.8) Maximum permissible advance Less comm.@ 1.5%(=17.50.015)

EXAMPLE OF FACTORING
C: Maximum permissible advance 14.00 Less com. 17.50.015 0.26 Funds made available to ABC 13.74 Interest charges collected in arrear 140.1690/360 0.56 Interest charge expressed as a percentage of funds made available 0.56/13.74 100=4.08 Annualized ROI is =17.35

FORMS OF FACTORING
Depending upon the features built into the factoring transactions, there can be different forms of factoring arrangements Following are the different types of factoring: 1. Recourse factoring 2.Non recourse factoring 3.Maturity factoring 4.Advance factoring 5. Invoice discounting 6.Full factoring 7.Bank Participating factoring 8.Supplier guarantee factoring 9.Cross Border factoring.

FORMS OF FACTORING
These features are, of course, common to most of the factoring arrangements, they are: The factor is responsible for collection of receivables and The factor maintains the sales ledger account of the client. RECOURSE FACTORING: The factor purchases the receivables on the condition that the loss arising on account of irrecoverable receivables will be borne by the client. For example, assume that a factor has advanced an amount of Rs 2.4 lakhs against a receivable of Rs 3 lakhs which turns out to be irrecoverable. Under a recourse factoring, the factor can recover the sum of Rs2.4 lakhs from the client.

NON-RECOURSE FACTORING
As the name implies, the factor has no recourse to the client if the debt purchased turns out to be irrecoverable. Since the factor bears the losses arising on account of irrecoverable debts (receivables), the factor charges a higher commission. (the additional commission is called the del credere commission). Non-recourse factoring is common in USA and UK. In India, factoring is done with recourse to the client.

MATURITY FACTORING
Under this type of factoring arrangement, the factor does not make any advance payment. The factor pays the client either on a guaranteed payment date or on the date of collection. The guaranteed payment date is usually fixed taking into account the previous ledger experience of the client and a period for slow collection after the due date of the invoice. ADVANCE FACTORING: Under this arrangement, the factor provides an advance varying between 75-80 percent value of the receivables factored. The balance
is paid upon collection or on the guaranteed payment date.

INVOICE DISCOUNTING
Strictly speaking, this is not a form of factoring because it does not carry the service elements of factoring. Under this arrangement, the factor provides a prepayment to the client against the purchase of book debts and charges interest for the period spanning the date of prepayment to the date of collection. The sales ledger administration and collection are carried out by the client;. The client provides the factor with periodical reports on the value of unpaid invoices and ageing schedule of debts. This facility is usually kept confidential. The customers (whose debt have been purchased by the factor) are not informed of the arrangement. Also called confidential F.

FULL FACTORING
This is the most comprehensive form of factoring combining the features of almost all the factoring services 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 financing.

BANK PARTICIPATION FACTORING


This arrangement can be viewed as an extension of advance factoring. Under this arrangement, a commercial bank participate in the transaction by providing an advance to the client against the reserves maintained by the factor. For example, assume that a factor has advanced 80 percent of the value of factor receivables and the CB provides an advance limited to 50% of the factor reserves. The client is required to fund 10% of the investment.

FUNCTIONS OF A FACTOR
From our discussion of the different forms of factoring, it is observed that a factor offers one or more of the following services: Administration of sales ledger. Provision of Collection facility. Financing trade debts. Credit control and credit protection Advisory services.

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 under copy 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 is clearly reflects the various open invoices outstanding on any given date. The factor also gives periodic reports to the client on the current status. In addition, the factor also maintains a customer-wise records of payments spread over a period of time so that any change pattern can be easily identified.

PROVISION OF COLLECTION FACILITY


The factor undertake to collect the receivables on behalf of the client relieving him of the problem involved in collection. This help the client to concentrate on other important areas. This also enables the client to reduce the cost of collection by way of savings in manpower, time and efforts. The expertise of the factor enables it to systematically follow up and make timely demands on the debtor to make payment. Collection of receivables can be considered as the most important function of a factor. The factor is generally not required to consult the client with regard to collection procedure . But he may consult the client if legal action has to be initiated in case of non-payment etc.

FINANCING TRADE DEBTORS


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 favour of the factor for which factor grants 80-85 % 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. Where the debts are factored without recourse, the factors obligation to the seller becomes absolute on the due date of the invoice whether or not the buyer makes the payment.

CREDIT CONTROL AND CREDIT PROTECTIONA


Assumption of credit risk is one of the important functions of a factor.This service is provided where debts are factored without recourse. The factor in consultation with the client fixes the credit limits for approved customers. Within these limits, the factor undertakes to purchase all trade debts of the customer without recourse. In other words, the factor assumes the risk of default. There are two important incidental benefits accruing to the client. First factoring relieves the client of the collections. Secondly, with access to extensive information available on the financial standing, credit rating and track records of the customer, factor is able to advise the client about creditworthness of potential customer

ADVISORY SERVICES
By virtue of specialised knowledge and experience in finance and credit dealings and access to extensive credit information, factor can provide variety of advisory services to their clients: Customers perception of the clients product, changes in marketing strategies, emerging trends. Audit of procedures followed for invoicing, delivery and dealing with sales returns. Introduction to the credit department of a bank / subsidiaries of banks engaged in leasing, hire purchase, merchant banking etc.

FORFAITING
Forfaiting is a form of trade financing undertaken to facilitate export transactions. In a forfaiting transaction, the exporter surrenders his right for claiming the payment for services rendered or goods supplied to the importer in favour of the forfaiter. A deed is prepared stating the same and the exporter receives cash payment from the facilitator. All the transactions of forfaiting are performed with the support of a bank, which assumes the default risk possessed by the importer. The bank would pay special attention towards the durability / perish ability nature of the goods, authentication of the product i.e. the date of manufacturing, packaging arrangements and other precautions adopted during the stage of shipment.

FORFAITING
After these checks and verifications, the banker provides the exporter with the funds. In other words, the forfaiting transaction helps an exporter with instant cash and eliminates his cash flow problems. Forfaiting is a relatively new concept. It is a speciali9zed form of factoring, which is undertaken on export transactions on a nonrecourse basis. This does not mean that factoring and forfaiting are one and the same type of trade financing.