Study on Factoring in India

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The History of Factoring
Have you ever wondered about the history of factoring? You may be surprised just how far back in history factoring goes. 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.

Today, factoring remains a viable alternative to more traditional financing. Thousands of businesses sell their accounts receivable to factors every year – amounting to an industry representing billions of dollars. And nearly any business with reliable customers and an invoicing system can take advantage of factoring

Factoring in India
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 to 90%) 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.

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. 5. Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement. 6. Factoring is a method of off balance sheet financing. 7. 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 vary from 1.5% to 3% per month depending upon the financial strength of the client's customer. 8. Indian firms offer factoring for invoices as low as 1000Rs 9. For 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 1. Disclosed and Undisclosed 2. Recourse and Non recourse 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 non recourse. 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 non recourse. 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

Recourse v. Non-Recourse Factoring
When factoring invoices, there are typically two types of accounts receivable factoring offered by factors - recourse and non-recourse factoring. Factoring with recourse is where the client selling the invoice is required to buy the invoice back from the factor if it goes uncollected for a fixed number of days, thus sharing the risk between the client and the factor. Factoring without recourse is where the client sells the invoice to the factor and the factor bears all the risk for collection of the invoice. Both options have pros and cons that need to be weighed in your decision as you decide which type of factoring arrangement to go with.

Factoring with recourse is generally more common in most industries because the client selling the invoice shares the risk with the factor. Factoring with recourse is generally a less expensive form of factoring because the factor bears less risk. Additionally, if your business rarely writes off bad receivables, factoring with recourse may be your best bet because you can be confident that you will collect on the invoice and save money on factoring fees. The down side is you may have to buy back an invoice if you or the factor are unable to collect the invoice in the specified time outlined in your factoring agreement. Factoring without recourse is a good option when the collectibility of your invoices is uncertain or you just don't want to share in the risk of collection. Non-recourse factoring is common in certain industries, such as transportation, but is generally less common throughout most industries. Moreover, non-recourse factoring will incur slightly higher fees than factoring with recourse. Regardless of the option you choose for factoring, be sure to weigh the pros and cons of each type of factoring. And remember, the more risk you are willing to take generally decreases the amount of factoring fees you will pay.

About Sbi Factors

SBI Factors, a subsidiary of State Bank Of India, is one of the leading factoring companies in India with an asset base of Rs 1908.00 crores as on March 31, 2008. It is the first factoring company to be set up in India. It was incorporated in February 1991 and commenced business operations from April 1991. State Bank of India and its 2 associate banks have a 70% stake in SBI Factors while 20% is held by Small Industries Development Bank Of India (SIDBI) and 10% by Union bank of India . As on March 31, 2008 , it has a maximum market share in factoring business in India.

There are two types of factoring undertaken here: Domestic factoring Export factoring

Domestic factoring

Bill 2 cash (Receivables Factoring Facility): Bill 2 Cash is a domestic factoring facility offered by us where the seller invoices the goods to the buyer, assigns the same to SBI Factors and receives prepayment up to 90% of the invoice value immediately. The balance amount is paid to the client when the customer pays us. This facility can be “With recourse” or “Non recourse”Recourse Factoring: In recourse factoring , seller undertakes to collect the debt from the buyer. In the event of the buyer failing to pay the amount on maturity, factor will recover the amount from the client. Non recourse Factoring :In Non recourse factoring, factor undertakes to collect the debts from the buyer. In other words, in case the buyer fails to pay, the factor will have „no recourse to the seller and will absorb the bad debts himself. The facility covers default by the buyer on account of insolvency or willful default of the buyer. Cash 4 Purchase (Purchase Bill Factoring ) : Cash for purchase is an attractive avenue of finance offered by us that facilitates instant

payment for purchases made. Generally sanctioned in conjunction with Receivable factoring facility or Export factoring facility, Cash 4 Purchase empowers purchaser to bargain for cash terms, best quality & immediate deliver

Export factoring
Vishwavyapaar (Export Factoring Facility): Our Export Factoring service offers you a complete package to help you develop your overseas business profitably and with confidence. Under Export Factoring, we factor invoices drawn on overseas buyers and make a prepayment of up to 90% of the invoice amount, immediately. Under two-factor system, the factor handling the collection of export receivables of clients (exporters) is called Export Factor (EF) and the factor in buyer‟s country who undertake collection and credit protection services is called Import factor. The following steps are involved:
    

The exporter ships the goods to importer. The exporter assigns his invoices through the export factor to the import factor who assumes the credit risk. (as per prior arrangement). The Export factor prepays invoices The importer pays the proceeds to the Import factor, who transfers the amount to Export factor The export factor deducts prepayment already made, other charges and pays the balance proceeds to the exporter.

The benefits accruing to you from Export Factoring would be:
  

100% credit cover, as compared to 80% offered by export credit agencies.(In case you get the facility from a bank, you will have to go in for an ECA cover.) Claims will be settled in invoice currency, as against in domestic currency in case of bank finance. Our counterpart, the “Import Factor”, will be located in the Importer‟s country, which ensures better due diligence on the latter.

HSBC

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 International Factoring Distributor Finance

HSBC currently offers both domestic and international factoring products.

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 on a Without Recourse Basis. Payments of all your service and utility bills could be done through our Vendor Finance product. These could include for example, courier payments, electricity bills payments. 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. 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. 7 - Step 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 Importer's 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 upto 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 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. In the international product suite, apart from the existing export-factoring product, we are now poised to launch import factoring as well. That will make us the first and only Bank offering the entire bouquet of factoring products to customers in India.

Distributor Finance Programme (DFP)

You can use the Distributor Finance Programme (DFP) to set up a financing and collection arrangement for your delivery chain. The credit worthiness of distributors is established independently by HSBC and credit limits are set up on each distributor. Regular MIS from the bank's end to both you and your distributors ensures that the sales ledger remains updated at all times and frees you from reconciliation issues. Our approach is to become your business partner providing value-added services over and above the basic funding against your receivables from the channel. This allows you to focus the efforts of your sales team on actual sales rather than collection. Our current portfolio carries a healthy mix of corporate clients across various industry sectors viz. Telecommunications, Automotive components, FMCG and Textiles, to name a few

Global Trade Finance Limited (GTF) Global Trade Finance Limited (GTF) is the only provider of international factoring, domestic factoring and forfaiting services under one roof in India. GTF has established itself as a market leader in international factoring providing value added services to its clients. GTF is headquartered in Mumbai with six regional offices - one each in New Delhi, Bangalore, Chennai, Hyderabad, Ahmedabad and Kolkata. GTF aims to be the premier export and import solution provider in India offering professional quality services on an e-commerce platform. GTF commenced operations in September 2001, as a joint venture promoted by Export Import Bank of India (Exim Bank); West LB, Germany; and IFC, Washington (the private sector arm of World Bank). In December 2004, the shareholding pattern became 40% with Exim Bank; 38.5% with FIM Bank, Malta; 12.5% with IFC, Washington; and 9% with Bank of Maharashtra. The current shareholding pattern is 92.85% with State Bank of India and 7.15% with Bank of Maharashtra. It has received the necessary licences and Authorized Dealer status from RBI for conducting export and import factoring and forfaiting business and foreign currency operations in India. GTF is a member of Factors Chain International, a global association of international factoring companies Established in 1968, FCI has played a major role in bringing factoring into most countries and today has a membership of 247 factoring companies operating in 66 countries. GTF also has arrangements with credit insurers over the world for providing credit protection. International trade, on the basis of LC's is gradually becoming extinct. "Open Account" and "Extended Credit" is becoming a pre-requisite for increasing sales volume in global market. GTF helps this need with its export factoring product that provides credit assessment, credit protection, financing, and collection services to exporters for regular sales on open account terms. GTF uses a high end customized IT platform to process and deliver its services. With a short turn around time in approval of facilities. GTF is the only factoring company in India to offer online web access to its clients for accessing their accounts. GTF's "Client Access" module is custom made to suit its business profile and caters to client requirements.

The Cost of Factoring
If your business is growing quickly, turns receivables slowly or operates in an industry that banks are traditionally reluctant to lend to, you know that factoring may be your only option to obtain working capital. On the other hand, you may have spent weeks studying all of your options for financing your business and have decided that factoring might be right for you because it is easy, has very little paperwork compared to traditional financing, and is based on the credit of your customers rather than yours. Either way, there are a few things you need to

understand about factoring before you jump in head first Keep in mind that there are many benefits to factoring. However the first thing you need to know about factoring is that it will generally cost your business more than traditional financing. When a factor buys your invoice at a discount, the discount percentage may not sound too bad. However, keep in mind that the discount rate multiplied by the turn ratio equals the effective interest rate you are paying by factoring. For example, if a factor buys your invoice at a 1.5% discount for 30 days, you are effectively paying 18% interest (1.5% x turn ratio of 12, which is calculated by dividing 30 into 365 days). And obviously the higher the discount rate or the shorter the terms, the effective interest you pay increases. Second, factoring companies generally don't explain their fees in terms of interest rates. Technically, factoring fees is not interest; it is a fee. A factor is not going to sit you down and let you know that they are effectively charging you 18, 24 or 36 perecnt interest. It is not in their best interest to do that. Third, make sure you understand what type of factoring facility you are entering into. Generally, your options will be to factor with or without recourse. If you factor without recourse, once you have sold your invoice to the factor, you are not liable if your customer fails to make payment to the factor. If you factor with recourse and your customer fails to pay the factor, you will most likely be obligated to pay the factor for the invoice or replace it with a new invoice at no cost to the factor. Before entering into a contract with a factor, be sure you understand if you are entering into a recourse or nonrecourse agreement and know exactly what the terms are. Finally, make sure that when you select a factor to work with you are comfortable with them. Some factors only look out for their own interests and try to take advantage of those who don't understand the process that well. A good factor will view his relationship with his clients as a partnership. The relationship has to be a win-win relationship. A good, reputable factor will not try and hide the true cost of factoring from his clients and will often times encourage his clients to develop a financial plan so the client won't have to factor any longer than necessary. A good factor understands that if he treats his clients with fairness and professionalism, his clients will ultimately recommend him to others. Factoring may be your financing option of choice, or it may be your only option. Regardless of your reason for choosing to factor, it is best to know all the facts and circumstances before entering into a factoring agreement.

Benefits of Factoring
There are many benefits to companies that choose to factor. In Addition to avoiding all the paper work associated with obtaining traditional financing, factoring is easy and generally provides instant cash. Below is a list of additional benefits of factoring:

Receive an Influx of Working Capital - The primary benefit of factoring is that it helps your business get the working capital it needs without taking on new debt or dilluting ownership of your company by bringing in new investors. Because today's economic environment is highly competitive, many businesses are under immense pressure to improve operations and undertake cost cutting measures in order to stay profitable. These problems are compounded for small businesses becasue most small businesses are often times understaffed to begin with. As a result, owners of small businesses frequently spend more time on cash flow and customer credit issues rather than on their primary objectives of growing their business, increasing sales, managing marketing campaigns and improving employee productivity. Many small businesses experience serious cash flow problems because their cash is tied up in their accounts receivable. For businesses that are growing, the cash flow problems can be even worse because more and more of their capital is not in their bank account, but is on the balance sheet as receivables. Most businesses want to grow and expand, but if appropriate planning is not done, an entire business will feel the squeeze because it is under capitalized. Invoice factoring is a solution to free up your capital and have it available when you need it. Your business will be able to invest resources in areas where it can help you become more profitable, such as payment discounts or taking advantage of promtional prices for inventory or supplies. Improve Cash Flow Without Borrowing From a Bank - You can eliminate long billing cycles and receive cash for your outstanding invoices generally within 48 hours of less. Since factoring is not a loan, you take on no new debt and maintain your company's leverage to take on new debt in the future. Capitalize on Supplier Discounts - Many suppliers offer discounts if they are paid in a short period of time. By factoring, you accelerate your cash flow allowing you to pay your suppliers earlier and take advantage of supplier discounts or buy in larger quantities. Build or Repair Your Credit Rating and Credit Score - Since factoring will give you immediate cash, you can pay your bills on time, or possibly even early, allowing you to build or repair your credit rating. Improving your credit rating and raising your credit score will give you increased borrowing power when you need it. Spend More Time Building Your Business and Less Time Collecting Money - When you factor your invoices, you have the cash you need to operate your business. As a result, you can spend more time on the things that matter - sales, quality control, customer service, and production operations. By factoring, the issue of 'collecting' will be off your mind. Increase Your Company's Sales By Offering Better Terms to Your Customers - If you choose to Factor, you may offer your customers better payment terms to entice them to do more business with you. Additionally, you will be in a position to extend credit terms to larger customers without requiring them to pay COD. Secure Capital By Leveraging Your Assets - Because your ability to factor is based on the

credit worthiness of your customers and not you, you can get the cash your business needs by leveraging your outstanding receivables.

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