Financial Services

PRESENTED BY:MEGHA KHANDELWAL MBA 4TH SEMESTER

WHAT IS FACTORING ?
Factoring is a financial transaction whereby a business owner sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on the understanding that the Factor will pay for the Book Debts as and when they are collected or on a guaranteed payment date. Normally, the Factor makes a part payment (usually upto 80%) immediately after the debts are purchased thereby providing immediate liquidity to the Client. So, a Factor is, a) A Financial Intermediary

FACTORING
Factoring is of recent origin in Indian Context. Kalyana Sundaram Committee factoring in 1989. recommended introduction of

Banking Regulation Act, 1949, was amended in 1991 for Banks setting up factoring services. SBI/Canara Bank have set up their Factoring Subsidiaries: SBI Factors Ltd., (April, 1991) Canara Bank Factors Ltd., (August, 1991). RBI has permitted Banks to undertake factoring services through subsidiaries.

PROCESS OF FACTORING
There are three main parties in Factoring arrangements: a) b) c) Supplier or Seller (Client) Buyer or Debtor (Customer) Financial Intermediary (Factor)

CLIENT

CUSTOMER

FACTOR

Features Of Factoring
1)

2) 3) 4) 5)

Period for factoring is 90 to 180 days. Some factoring companies allow even more than 180 days. It is considered as costly source of finance. These companies can leverage on the financial strength of their customers. Bad debts will not be considered for factoring. Off balance sheet method.

SERVICES OFFERED BY A FACTOR

1. 2. 3. 4.

Follow-up and collection of Receivables from Clients. Purchase of Receivables with or without recourse. Help in getting information and credit line on customers (credit protection) Sorting out disputes, if any, due to his relationship with Buyer & Seller.

5.

Advisory Services.

PROCESS INVOLVED IN FACTORING

Client concludes a credit sale with a customer.

Client sells the customers account to the Factor and notifies the customer.
Factor makes part payment (advance) against account purchased, after adjusting for commission and interest on the advance.

Factor maintains the customers account and follows up for payment.

Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date.

CHARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage of value of Debts purchased) (1.5% to 3%) Per month. For making immediate part payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks.

TYPES OF FACTORING
Recourse Factoring Non-recourse Factoring Maturity Factoring Advance Factoring Cross-border Factoring

RECOURSE FACTORING

Up to 75% to 85% of the Invoice Receivable is factored. Interest is charged from the date of advance to the date of collection. Factor purchases Receivables on the condition that loss arising on account of non-recovery will be borne by the Client. Credit Risk is with the Client. Factor does not participate in the credit sanction process. In India, factoring is done with recourse.

NON-RECOURSE FACTORING

Factor purchases Receivables on the condition that the Factor has no recourse to the Client, if the debt turns out to be nonrecoverable. Credit risk is with the Factor. Higher commission is charged. Factor participates in credit sanction process and approves credit limit given by the Client to the Customer. In USA/UK, factoring is commonly done without recourse.

MATURITY FACTORING

Factor does not make any advance payment to the Client.

Pays on guaranteed payment date or on collection of Receivables.

Guaranteed payment date is usually fixed taking into account previous collection experience of the Client. Nominal Commission is charged. No risk to Factor.

Advance Factoring

Under Advance Factoring arrangements, certain percentage of receivables is paid in advance to the client, the balance being paid on the guaranteed payment date.

CROSS - BORDER FACTORING

It is similar to domestic factoring except that there are four parties, viz., a) Exporter,(selling firm) b) Export Factor, c) Import Factor, and d) Importer.(customer) It is also called two-factor system of factoring. Exporter (Client) enters into factoring arrangement with Export Factor in his country and assigns to him export receivables. Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & collection of payment for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import Factor. Import Factor collects payment and remits to Export Factor who passes on the proceeds to the Exporter after adjusting his advance, if any. Where foreign currency is involved, Factor covers exchange risk also.

Advantages of Factoring
Factoring provides a large and quick boost to cash flow. This may be very valuable for businesses that are short of working capital. There are many factoring companies, so prices are usually competitive It assists smoother cash flow and financial planning Some customers may respect factors and pay more quickly Factors can prove an excellent strategic - as well as financial - resource when planning business growth. you will be protected from bad debts if you choose nonrecourse factoring. cash is released as soon as orders are invoiced and is available for capital investment and funding of your next orders

Disadvantages Of Factoring
Costlier Deleterious Effect On the Credit Worthiness Difficult to Exit the Agreement. Reliance On Factor

WHY FACTORING HAS NOT BECOME POPULAR IN INDIA

Banks reluctance to provide factoring services

Banks resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines).
Problems in recovery. Cost of transaction becomes high.

STATUTES APPLICABLE TO FACTORING

Factoring transactions in India are governed by the following Acts:Indian Contract Act Sale of Goods Act Transfer of Property Act Banking Regulation Act. Foreign Exchange Regulation Act.

a) b) c) d) e)

FORFAITING
The terms forfeiting is originated from a old French word forfait, which means to surrender ones right on something to someone else. The exporter surrenders their right to the forfeiter to receive future payment from the buyer to whom goods have been supplied.In international trade, forfeiting may be defined as the purchasing of an exporters(seller) receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk of not receiving the payment from the importer. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is a shorttermed receivables (within 90 days) and is more related to receivables against commodity sales.

FORFAITING

(contd)

Exporter under Forfaiting surrenders his right for claiming payment for services rendered or goods supplied to Importer in favour of Forefaiter. Bank (Forefaiter) assumes default risk possessed by the Importer. Credit Sale gets converted as Cash Sale. Forfaiting is arrangement without recourse to the Exporter (seller) Operated on fixed rate basis (discount) Finance available upto 100% of value (unlike in Factoring)

Introduced in the country in 1992.

How forfeiting Works in International Trade

The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the discount rate. The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a contract with the forfeiter. Export takes place against documents guaranteed by the importers bank and discounts the bill with the forfeiter and presents the same to the importer for payment on

Documentary Requirements

In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below: Invoice : Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice. Shipping Bill and GR form : Details of the forfeiting costs are to be included along with the other details, such as commission insurance, normally included in the "Analysis of Export Value "on the shipping bill.

Need Of Forfaiting

It is non recourse and off balance sheet financing. It eliminates all the risk from the exporters books. Credit limit Eliminates exchange rate fluctuation.

CHARACTERISTICS OF FORFAITING

Converts bills into cash transactions, providing liquidity and cash flow to Exporter. Absolves Exporter from Cross-border political or conversion risk associated with Export Receivables. Finance available without recourse. Off balance sheet method. Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise. Credit pd. Can range 60days to 5 yrs.

COSTS INVOLVED IN FORFAITING

Commitment Fee:- Payable to Forfaiter by Exporter in consideration of forefaiting services. Commission:- Ranges from 0.5% to 1.5% per annum. Discount Fee:- Discount rate based on LIBOR for the period concerned. Documentation Fee:- where elaborate legal formalities are involved. Service Charges:- payable to Exim Bank. Grace days:- They represent the anticipated number of days required for transmission and receipts of funds at maturity.it normally ranges from 2-5 days and can be extended upto 15 days.

Advantages Of Forfeiting
Simplicity and Flexibility. Non Recourse basis. Fixed Interest Rates and no currency rates No need to carry recaivables EXIM Bank No hassles Of collection Simple documentation

Disadvantages Of forfeiting
Higher interest Rates. Unfavorable Exchange and Administrative Controls. No Legal Framework. Insufficient Data.

WHY FORFAITING HAS NOT DEVELOPED

Relatively new concept in India. Depreciating Rupee

No ECGC (Export credit gurantee corporation) Cover

High cost of funds minimum cost of transactions (USD 250,000/-) RBI Guidelines are vague.

Very few institutions offer the services in India. Exim Bank alone does.
Long term advances are not favoured by Banks as hedging becomes difficult. Lack of awareness.

FACTORING vs. FORFAITING

POINTS OF DIFFERENCE FACTORING FORFAITING

Extent of Finance Usually 75 80% of the value of the invoice

Credit Worthiness Factor does the credit rating in case of nonrecourse factoring transaction

100% of Invoice value

The Forfaiting Bank relies on the creditability of the Avalling Bank.

Services provided Day-to-day administration of sales and other allied services

Recourse Term of maturity With or without recourse For long term maturity

No services are provided

Always without recourse For short term maturities

Discounting of bill
A bill discounting or a bill of exchange is a short term, negotiable and self-liquidating money market instrument. According to Negotiable Instruments Act, 1881: The bills of exchange is an instrument in writing, containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money, only to, or to the order of, a certain person, or to the bearer of that instrument. Bill discounting is a major activity of the smaller banks. Under this type of lending, bank takes the bill drawn by borrower on his (borrowers) customer and pays him immediately deducting some amount as discount/commission. The bank then presents the bill to the borrower or his customer pays the bank a predetermined interest depending upon the term of transaction.

Discounting a Bill
If the drawer of the bill does not want to wait till the due date of the bill and is in need of money, he may sell his bill to a bank at a certain rate of discount. The bill will be endorsed by the drawer with a signed and dated order to pay the bank. The bank will become the holder and the owner of the bill. After getting the bill, the bank will pay cash to the drawer equal to the face value less interest or discount at an agreed rate. This process is know as discounting of a bill of exchange.

Parties Of Bill Of Exchange

There are three parties to a bill of exchange as under: 1) Drawer: The person who draws or writes the Bill Of Exchange is called the Drawer. The Drawer must be the seller or creditor. 2) Drawee: The Drawee is the person on whom the bill is drawn. He is the purchaser or debtor who is ordered by the Drawer to pay the amount. 3) Payee: The person who has the right to receive the amount of the bill is called the Payee, the Payee may be a third person or the Drawer himself

Types Of Bills
1. Demand Bill Payable immediately on presentment to the drawee. A bill in which no time of payment or due date is specified is also termed as Demand Bill. 2. Usance Bill This bill is also called Time Bill. The term Usance refers to the time period for payment of bills. 3. Documentary Bill These B/E are accompanied by documents that confirm trade has taken place between the buyer and the seller of goods. These documents includes the invoices and the other documents of title such as railway receipts, lorry receipts and bills of lading issued by custom officials.

Types Of Bills(contd.)
4. Clean Bills These Bills are not accompanied by any documents. Interest rate charged is higher than documentary bill 5. Inland Bills: Bills that are drawn on Indian residents are called Inland bills. Such bills may be endorsed in a foreign country, or may remain in circulation in foreign countries. A bill drawn in a foreign country is considered an inland bill if it is drawn on a resident of India. 6.Hundis: Indigeneous bills of exchange and promissory notes are known as hundis. These are used for financing agriculture and inland trade. They are handled by various types of Indigeneous bankers. 7. Supply Bills: Bills that are drawn by a supplier or contractor on a government or semi-government department for supplies made are supply bills. These bills are not accepted by government Departments and therefore, do not enjoy the status of a negotiable instrument. 8. Accommodation Bills: Such bills do not involve any sale and purchase of goods, rather they are drawn without any consideration. The purpose of such bills is to help one party or both

A BE at Sight n Drawer n Payee Are The Same

RM50,000
2007

K. Lumpur
30TH March

Pay to me or my order at sight the sum of RM50,000 Arshad To: Saad

35

A BE at Where Three Parties Are Named

RM50,000 Lumpur
2007

K.
30TH March

90 days after sight pay Shahril or order the sum of RM50,000 Arshad

To: Saad

36

Special features
1. 2. 3. 4. 5. 6.

7.
8.

A Bill Of Exchange is an instrument in writing It must be signed by the maker It contains an unconditional order The order must be to pay money and money only The sum payable must be specific The amount must be paid within a stipulated time The name of the drawee must be clearly mentioned It must be dated and stamped

Every drawer or receiver of a bill has four options for him. He can retain the bill till the due date. He can send the bill to his bank for collection. Bank will present the bill before drawee on due date and will collect the amount for drawer. He can endorse the bill to one of his creditors in settlement of his own debts. He can discount it with his bank if he is in need of money and cannot wait till the due date. In the same way every acceptor has four possibilities. He may pay the amount of bill on presentation. He may refuse to honor the bill. It is called dishonor of a bill of exchange He may request the drawer to renew the bill (extending the period of payment). He may get the bill retired. (paying his obligation before the due date).

Advantages of Bill of Exchange

1. 2. 3. 4.

5.

A Bill of Exchange is used in settlement of debts It fixes the date of payment It is a written and signed acknowledgement of debt A debtor enjoys full period of credit A drawer can convert the bill into cash by getting it discounted with the bank

Dishonor of Bill

A bill of exchange is said to be dishonored when its acceptor refuses to pay the amount of the bill to the holder of the bill on its maturity. The bill then becomes useless and the party from whom it has been received will be liable to pay for the amount. It is very important to know that, when a bill is dishonored, in whose possession it was? Because when a bill is dishonored, all the parties involved are effected and books of accounts of all the parties have to be adjusted. For example, A draws a bill of $5,000 on B and B accepts it and returns it to A. A retains the bill in his possession till the due date. On the due date the bill is not honored by the acceptor. We can see, there are two parties involved whose books are to be adjusted. If suppose, A has discounted or endorsed the bill, then there are three parties involved and books of accounts of all the parties are effected.

Noting Charges

When a bill is dishonored, the holder of the bill, (drawer, banker, endorsee or any other party) in order to make a strong ground for drawing legal proceeding against the acceptor may get the official recognition that the bill has been dishonored. He goes to an official called notary public, and gives the bill to him. The notary public will present the bill for payment again to the acceptor and if the money is received he will hand over the money to the original party. But if the bill is again dishonored, the notary public will note the fact of dishonor and the reasons of the dishonor on the bill and will give the bill back to the holder of the bill. It is now a strong evidence against the acceptor, in case, if the case is filed in the court. For this service, the notary public will charge a small fee obviously from the holder of the bill. This fee is known as "noting charges" and is always recoverable from the party responsible for dishonor (the acceptor). It must be remembered that noting charges are not the expenses of any party involved. They are always expenses of the acceptor in whose books they will be debited.

Who Pays Noting Charges:

If the bill is retained by the drawer, the drawer will pay the noting charges. If the bill has been discounted the bank will pay. If the bill has been endorsed to the endorsee, the endorsee will pay. If the endorsee has endorsed the bill to his creditor (a new endorsee), the new endorsee will pay. But the new endorsee will recover the noting charges from first endorsee, the first endorsee from the drawer and ultimately the drawer from the acceptor (being an expense of

Working Of Discounting Of Bills

1) Examination of bills 2) Crediting customer Account 3) Control over accounts 4) Sending bills for collection 5) Action by Branch

Precautions in bill Discounting

1) Considerations about the parties 2) Bill is complete in all respects 3) Proper Documents to Accompany the Bill

FACTORING vs BILLS DISCOUNTING

BILL DISCOUNTING
1.

Bill is separately examined and discounted.

1.

FACTORING Pre-payment made against all unpaid and not due invoices purchased by Factor.

2.

Bill discounting facility implies only provision of finance. Bill discounting is not an offbalance sheet method mode of financing.

2.

A Factor also provides other services likes Sales Ledger maintainence and advisory services.
Factoring is an off-balance mode of financing.

3.

3.

FACTORING vs BILLS DISCOUNTING

BILLS DISCOUNTING
4.

(contd)

FACTORING
4.

Bills discounting is usually done with recourse.

Factoring can be done without or without recourse to client. In India, it is done with recourse. Debts purchased factoring cannot rediscounted, they only be refinanced. for be can

5.

Discounted bills may be rediscounted several times before they mature for payment.

5.

REDISCOUNTING

OF BILLS

Rediscounting occurs when a bank itself in need of funds, and takes some of the paper that it has discounted for customers to some other bank and discounts it: i.e.. re-discounts it. It is the act of discounting a short term negotiable debt instrument for a second time. Banks may re-discount these short term debt securities to assist the movement of a market that has a high demand for loans. When there is low liquidity in the market, banks can generate cash by re-discounting short term securities.

Documents Required For Rediscounting of Bills

1) The Photocopy of applicants Business License And Financial operation Permit. 2) Re-discount applicants Certificate of Re-discount Business Qualifications. 3) The authorized commission letter to the person conducting the application with agency's corporate seal and the signature or the personal seal of agent. 4) The identification of the person conducting the application. 5) The original bill and photocopy of both sides of the commercial bills. 6) Photocopy of discount voucher, for commercial acceptance. 7) Photocopy of the inquiry letter and inquiry-response letter with transacting clients business seal(red ink seal). 8) The application form of establishing re-discount relationship with the corporate seal and legal persons private seal or signature. 9) The discount vouchers with the corporate or finacial seal, the seals must be identical to the ones preserved at ICBC. 10) Other documents required by Bill Business Office.

Working of rediscounting of bills

Eligible banks are required to apply to the RBI in the prescribed form, giving their estimated requirements for the 12 months ending October of each year, and limits are sanctioned / renewed for a period of one year running from 1st November to 31st October of the following year. The RBI presents for payment, bills of exchange rediscounted by it and such bills have to taken delivery of by the rediscounting banks against payment, not less than three working days before the dates of maturity of the bills concerned. In case the bills are retired before the dates, pro-rata refund of discount is allowed by the RBI. For rediscounting purposes, bills already rediscounted with the RBI may be lodged with it. The unexpired period of the usance of the bills so offered should not be less than 30 days and the bills should to bear the endorsement of the discounting bank in favor of a party other than the RBI.

THANK YOU..