Factoring

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Factoring

Factoring

• In order to increase or improve cash flow, companies may sell
their accounts receivable to A factor or agent at A discount. This is known as factoring.

•Factoring is a financial option for the management of
receivables. In simple definition it is the conversion of credit sales into cash

• A financing method in which a business owner sells accounts
receivable at a discount to a third-party funding source to raise capital

•One of the oldest forms of business financing, factoring is the
cash-management tool of choice for many companies. Factoring is very common in certain industries, such as the clothing industry, where long receivables are part of the business cycle.

Factoring

• In a typical factoring arrangement, the client (you) makes a
sale, delivers the product or service and generates an invoice. The factor (the funding source) buys the right to collect on that invoice by agreeing to pay you the invoice's face value less a discount--typically 2 to 6 percent. The factor pays 75 percent to 80 percent of the face value immediately and forwards the remainder (less the discount) when your customer pays.

•The three parties directly involved are: the one who sells the
receivable, the debtor, and the factor.

Factoring

•So, a Factor is,

•A Financial Intermediary •That buys invoices of a manufacturer or a trader, at a
discount, and •Takes responsibility for collection of payments.

•The parties involved in the factoring transaction are:•Supplier or Seller (Client) •Buyer or Debtor (Customer) •Financial Intermediary (Factor)

Factoring

Characteristics of factoring

•Usually the period for factoring is 90 to 150 days. Some
factoring companies allow even more than 150 days.

•Factoring is considered to be a costly source of finance
compared to other sources of short term borrowings.

•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.

•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.

PROCESS INVOLVED IN FACTORING

•Client concludes a credit sale with a customer.

•Client sells the customer’s 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 customer’s 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 the guaranteed payment date.

Characteristics of factoring

•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 vary from 1.5% to 3% per month depending upon the financial strength of the client's customer.

•Indian firms offer factoring for invoices as low as 1000Rs •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).

Types of Factoring

•Recourse and Non-recourse Factoring:

•In recourse factoring, the factor turns to the client (seller),
if the receivables become bad, i.e. if the customer does not pay on maturity. The risk of bad receivables remains with the client, and the factor does not assume any risk associated with the receivables. The factor provides the service of receivables collection, but does not cover the risk of the buyer failing to pay the debt. The factor can recover the funds from the seller (client) in the case of such default. The seller assumes the risks associated with the credit and the buyer's creditworthiness. The factor charges the seller for the management of receivables and debt collection services, while also charging interest on the amount advanced to the client (seller).

Types of Factoring

•Recourse and Non-recourse Factoring:

•In non-recourse factoring, the factor assumes the risk of
non-payment by the client's customers. The factor cannot demand any outstanding amount from the client (seller). The commission or fees charged for non-recourse factoring services are higher than for recourse factoring. The factor assumes the risk of non-payment on maturity and consequently takes an additional fee called a del credere commission.

Types of Factoring

•Domestic and Export Factoring:
•Domestic and export factoring differ in the number of
parties involved.

•In domestic factoring three parties are involved (the seller,
the buyer, and the factor), while in export factoring there are four (the seller, the buyer, the domestic factor, and the factor abroad).

•In domestic factoring, the factor mediates between the
seller and the buyer. All three parties are located in the same country.

•Export factoring is similar to domestic factoring, except
there are four parties involved. There are consequently two factors involved in the transaction, and it is referred to as the two-factor system of factoring.

Types of Factoring

•Disclosed and Undisclosed Factoring:

•In disclosed factoring (factoring with notification), the
seller notifies the buyer of the factor's name in the invoice, telling the buyer to make payment to the factor on due date. Disclosed factoring can be on the basis of either recourse or non-recourse factoring.

•In undisclosed factoring (factoring without notification),
the seller does not notify the buyer of the existence of the factoring deal, so the name of the factor is not disclosed on the invoice. In undisclosed factoring, the factor nonetheless retains control, maintaining the seller's sales ledger and providing short-term finance against sales invoices, even though the transactions take place in the name of the seller.

Types of Factoring

•Full Factoring and Limited Factoring:

•In full factoring, the factor provides almost all the
services: collection, keeping the sales ledger, credit control and credit insurance. This is also known as Conventional Factoring or Old Line Factoring. The factor can also provide other services based on client requirements: maturity-wise bill collection, keeping accounts, advance granting of limits to a limited discounting of invoices on a selective basis. Factors usually provide full factoring with recourse for good companies.

•In limited factoring, the factor chooses a limited number of
invoices to be the subject of the factoring agreement with the client (seller).

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.

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