10. Factoring
Transcript of 10. Factoring
WelcomeWelcome
Factoring &
Forfaiting
What is Factoring?
FACTORING is a “continuing arrangement” between a financial institution (the factor) and a business concern (the client) selling goods or services to trade customers (the customer) whereby the factor purchases the client’s accounts receivables/book debts
What is Factoring?
Alternatively factoring is a collection and financial service where by receivables are purchased by the factor and credit sales are converted into cash sales
What is Factoring?
Factoring is a powerful financial instrument specially designed to meet the post sales working capital requirements of the Industrial, Trade & Service sectors
It is a portfolio of complementary financial 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 to 90%) of the bill amount
Collection of debt is done either by the factor or the client depending upon the type of factoring
Factoring Services
Besides purchase of accounts receivables, a factor may provide a wide range of services such as:
a) Sales Ledger administration b) Debt Collection services c) Credit Information services d) Advisory services
Loan Vs Factoring
The emphasis is on the value of the receivable ( essentially a financial asset), not the firm’s credit worthiness
Factoring is not a loan, it is the purchase of a financial asset ( the receivable)
A bank loan involves two parties whereas factoring involves three
Non-Recourse Factoring
It is the most comprehensive type of factoring arrangement offering all types of services namely:
Finance Sales Ledger Administration Collection Debt Protection Advisory Services
Non-Recourse Factoring
It gives protection against bad debts to the client
In other words, in case the customer fails to pay, the factor will have ‘no recourse’ to the client and will have to absorb the bad debts himself
It is popular in developed countries
Recourse Factoring
In this type of factoring arrangement, the factor provides all types of facilities except debt protection
In other words, the client is responsible for any bad debts incurred
It is popular in developing countries
Invoice Discounting
Invoice discounting is also a variant of factoring
Under this, a factor provides finance against invoices backed by LCs of Banks
This enhances client’s liquidity by converting credit sales into cash sales
Finance is provided once LC opening bank confirms due date of payment
Rate of discount (interest) and charges are very competitive and in accordance with the market trends
Advance & Maturity Factoring
In advance factoring, the factor pays a pre-specified portion of the factored receivables and the balance is paid on collection
In maturity factoring, payment is made only on the guaranteed payment date or on the date of collection
Old Line Factoring
Old line factoring is also known as full factoring as it provides an entire spectrum of services such as:
CollectionCredit protectionSales Ledger administrationShort term finance
It includes all features of non-recourse and advance factoring
Undisclosed Factoring
In undisclosed factoring, the client’s customers are not notified of the factoring arrangement
The client himself undertakes sales ledger administration and collection of debts
Client has to pay the amount to the factor irrespective of whether customer has paid or not
Cross Border Factoring / International Factoring
In the international business transactions, factoring services are provided by factors of both countries
This is known as Cross Border Factoring / International Factoring
Factoring Mechanism
Client invoices his customer in the usual way-only adding a notification that the invoice is assigned to and must be paid to a FACTOR
Client submits copies of invoices to a FACTOR, accompanied by the receipted delivery challan or any other valid proof of dispatch
Factoring Mechanism
A FACTOR will provide pre-payment up to
80% of the invoice value Follows up with the customers for realization of payments due Balance payment made immediately on realization Sends monthly statement of account to keep the client informed of the factored invoices
Factoring Mechanism
Functions of a Factor
Instant Cash
Follow up and Speedy Collection
MIS Services
Sales Ledger Administration
Credit Protection
Advisory Services
Factoring Charges
Finance charge:
It is computed on the pre-payment outstandings in the account at monthly intervals
Service/Handling charge:
It is a nominal charge levied to cover the cost of services viz. collection, sales ledger management and periodical MIS reports. It ranges from 0.1% to 0.2% on the total value of invoices factored/ collected . The tax payable on Service/Handling charges is also recovered from clients
Benefits of Factoring (Client)
Credit sales are converted into cash Client will have substantial funds-up
to 80% of the factored invoices. It is much more than bank finance against credit sales. (Further increase is possible in exceptional cases.)
Client can offer competitive terms to his buyers and improve his sales and ultimately profit
With cash available for credit sales, client’s liquidity will improve and therefore, production cycle will be accelerated
Benefits of Factoring (Client)
Appraisal and documentation procedures are made simple and response time is very small
Cash disbursals are instantaneous Factoring provides much more than
bill discounting, like finance, collection, sales ledger administration, etc.
Client does not have to submit any periodical statements. On the contrary, a factor will provide classified periodical statement of outstanding invoices
Benefits of Factoring (Client)
Factoring replaces high cost market credit and enables purchases on cash basis availing cash discounts
The client is free from the tension of monitoring his sales ledger and can concentrate on production, marketing and other aspects
This results in a reduction in overhead expenses
The client can expand his business by exploring new market
Benefits of Factoring (Buyers)
Customers get adequate credit period for payment of assigned debts
Customers save on high bank charges and expenses
No Documentation except acknowledgement of the Notification letter
Factors furnish the customers with periodical statement of outstanding invoices factored on them
Factoring does not impinge on their rights vis-a-vis the supplier in respect of quality of goods, contractual obligations, etc.
Benefits of Factoring (Banks)
Factoring is not a threat to banking, it is a financial service complementary to that of the banks
Factoring improves liquidity of bank’s borrowers
Credit sales are closely monitored by the Factor and proceeds are routed through the clients accounts with the bank
Factoring improves the quality of advances of banks
International Factoring
Under Export Factoring, a factor in India factors export invoices drawn on overseas buyers and prepays the client an agreed percentage of the invoice value immediately
In international factoring, factoring services are provided by factors of both countries
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
International Factoring
In Export Factoring, the Export Factor appoints an Import Factor, who provides credit protection / exposure limits for a particular importer and only upon such approval the Export Factor provides financial assistance to the Indian Exporter
In view of this there is no requirement of a letter of credit or a credit insurance cover
Mechanism
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
Benefits to Exporters Elimination of the cost and delays
experienced in transacting business under LC
The import factor offers credit risk protection in case buyer does not pay invoices with in 90 days of due date
ECGC policy cost can be saved. There is reduction is administrative cost as the exporter will be dealing with only one Export Factor irrespective of the number of countries involved.
Benefits to Exporters
The exporter can obtain valuable information on the standing of the foreign buyers on trade customs and market potential in order to expand his business
The following up of receivables by import factor will speed up the collections
Usually, as factors provide finance up to 90% on export invoices, the exporter has an improved cash flow and his liquidity improves markedly
Benefits to Importers
He can pay invoices in the country locally
He deals with the local agency, i.e. the
Import Factor Minimum documentation required The cost of Letters of Credit and delay
on account of LC’s are eliminated. All communication is in his own language.
Factoring in India
1. Canbank Factors Ltd. Bangalore
2. Export Credit Guarantee Corporation of India Ltd, Factoring Division,Mumbai
3. Foremost Factors Limited, New Delhi
4. Global Trade Finance Limited, Mumbai
5. SBI Factors and Commercial Services Pvt. Ltd. Mumbai
6. The Hongkong and Shanghai Banking Corporation Ltd. Factoring & Receivables Finance ,Mumbai
Factoring in India
Number of Factoring companies:
7
Domestic Factoring Turnover (in Millions of EUR):
4,715
International Factoring Turnover (in Millions of EUR):
340
Total Factoring Turnover (in Millions of EUR):
5,055
Forfaiting
The word forfaiting is derived from the French term “ a forfait ” which means “relinquishing a right”
Forfaiting is the discounting of international trade receivable on a 100% "without recourse" basis
It is a form of suppliers credit involving the sale or purchase of receivables falling due at some future date
Forfaiting
Traditionally, forfaiting is fixed interest rate and medium term (3-5 years) financing
Forfaiting is generally suitable for high value exports like heavy machinery, capital goods, consumer durable, vehicles, bulk commodities, consultancy and construction contracts and project exports
Forfaiting
Unlike factoring, forfeiters typically work with the exporter who sells capital goods, commodities, or large projects from 180 days to up to seven years
In forfeiting, receivables are normally guaranteed by the importer’s bank, allowing the exporter to take the transaction off the balance sheet to enhance its key financial ratios
Characteristics of Forfaiting
100% financing without recourse to the seller of the obligation
Importer's obligation is normally
supported by a local bank guarantee
The debt is typically evidenced by Letter of credit, Bills of Exchange, Promissory Notes
Credit periods can range from 90 days to 10 years
Characteristics of Forfaiting
Amounts financed to be upwards of USD 2,50,000/-
Contract in any of the world's major convertible currencies can be financed
Finance to be either on a fixed (market norm) or floating rate basis
Benefits
Enhances competitive advantage Ability to provide vendor financing
making products more attractive Enables the exporter to do business
in risky countries Increases cash flow. Forfaiting
converts a credit-based transaction in to a cash transaction
Benefits
Elimination of the following Risks associated with cross border transactions:
Commercial Risk - The risk of non-
payment by a non-sovereign or private sector buyer or borrower in his home currency arising from insolvency
Political Risk - The risk of the borrower country government actions, which prevent or delay the repayment of export credits
Benefits
Transfer Risk - The risk of an inability
to convert local currency into the currency in which debt is denominated
Interest Risk - The risk of interest rate
fluctuations during the credit period of the transaction
Exchange Risk - The risk of exchange
rate fluctuations
Factoring - Exercise
Turnover = Rs. 60 Lacs ( 80% on Credit) Debtors = 1 month to pay
Factoring Proposal:
Factor pays 90% of credit sales Factor fee : 2% p.m. Factor commission : 4% of total debts Likely savings of management cost: Rs
21,600 Avoidance of bad debt : 1% of credit
sales
Factoring - Exercise
Bank Proposal :
Advance of 90% of the debts Rate of interest : 18% p.a. Processing fee : 2% of debts
Factoring - Exercise
Fee 0.02 x 0.90 x Rs. 4,00,000
Rs. 7,200
Commission 0.04 x Rs. 4,00,000 Rs. 16,000
Sub-total Rs. 23,200
Less ; Saving in cost
Management costs
Rs. 21, 600 / 12 Rs. 1,800
Savings in bad debts
0.01 x Rs. 4,00,000 Rs. 4,000
Sub-total Rs. 5,800
Net Cost of factoring Rs. 17,400
COST OF FACTORING
Factoring - Exercise
Interest 0.18 x 1/12 x o.90 x Rs. 4,00,000
Rs. 5,400
Processing Fee
0.02 x Rs. 4,00,000 Rs. 8,000
Bad Debts 0.01 x Rs. 4,00,000 Rs. 4,000
Cost of bank advance Rs. 17,400
COST OF BANK ADVANCE
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