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Factoring Study Material

Factoring is an arrangement between a financial intermediary called a "factor" and a seller of goods and services. The factor provides several services related to the seller's accounts receivables including purchasing receivables for immediate cash, administering the sales ledger, collecting payments from customers, and assuming losses from bad debts. Factoring differs from bill discounting in that it is an ongoing arrangement that handles all of a seller's receivables rather than specific invoices. The factor charges fees including a commission of 0.4-1% of invoice value and discount charges comparable to interest rates. There are different types of factoring such as recourse, non-recourse, advance, and invoice discounting.

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Dr.G.H.KERINAB BEENU
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129 views2 pages

Factoring Study Material

Factoring is an arrangement between a financial intermediary called a "factor" and a seller of goods and services. The factor provides several services related to the seller's accounts receivables including purchasing receivables for immediate cash, administering the sales ledger, collecting payments from customers, and assuming losses from bad debts. Factoring differs from bill discounting in that it is an ongoing arrangement that handles all of a seller's receivables rather than specific invoices. The factor charges fees including a commission of 0.4-1% of invoice value and discount charges comparable to interest rates. There are different types of factoring such as recourse, non-recourse, advance, and invoice discounting.

Uploaded by

Dr.G.H.KERINAB BEENU
Copyright
© Attribution Non-Commercial ShareAlike (BY-NC-SA)
We take content rights seriously. If you suspect this is your content, claim it here.
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FACTORING

Factoring is a ‘continuing’ arrangement between a financial intermediary called a ‘Factor’


and a ‘Seller’ (also called a Client) of goods and services. Based on the type of factoring,
the factor performs the following services in respect of the accounts receivables arising from
the sale of such goods and services.

 Purchase of all accounts receivables of the seller for immediate cash


 Administers the sales ledger of the seller
 Collects the accounts receivables
 Assumes the losses which may aisle from bade debts
 Provides relevant advisory services to the seller

Factors are usually subsidiaries of banks or private financial companies. It is to be noted


that factoring in a continuous arrangement and not related to a specific transaction. This
mean that the factor handles all the receivables arising out of the credit sales of the seller
company and just some specific bills or invoices as is done in a bill discounting agreement.

Mechanics of Factoring :

The factoring arrangement starts when the seller (client) concludes an agreement with the
factor, wherein the limits, charges and other terms and conditions are mutually agreed upon.
From then onwards, the client will pass on all credit sales to the factor. When the customer
places the order and the goods along with invoices are delivered by the client to the
customer, the client sells the customer’s account to the factor and also informs the customer
that payment has to be made to the factor. A copy of the invoice is also sent to the factor.

The factor purchases the invoices and makes prepayment, generally up to 80% of the invoice
amount. Just as in the case of cash credit, for factoring also a ‘drawing power’ is fixed based
on a margin which is normally around 20%.

The client is free to withdraw funds up to the drawing power. The factors sends monthly
statements showing outstanding balances to the customer, copies of which are also sent to
the client. The factor also carries follow-up if the customer does not pay by the due date.
Once the customer makes payment the factor, the balance amount due to client is paid by the
factor.

Servicing and Discount Charges :

For rendering the services of collection and maintenance of sales ledger, the factor charges a
commission which varies between 0.4% to 1% of the invoice value, depending upon the
volume of operations. This service charge is collected at the time of purchase of invoices by
the factor. For making an immediate part-payment to the client, the factor collects discount
charges from the client. The discount charges are comparable to bank interest rates in that it
is calculated for the period between the date of advance payment by the factor to the client
and the date of collection by the factor from the customers. These are collected monthly.

Types of Factoring :
Factoring can be classified into many types. The types of factoring prevalent in
India today are as follows:

1. Recourse Factoring : Under recourse factoring, the factor purchases the receivables on
the condition that any loss arising out of irrecoverable receivables will be borne by the client.
In other words, the factor has recourse to the client if the receivables purchased turn out to
be irrecoverable.

2. Non-recourse or Full Factoring : As the name implies, the factor has no recourse to the
cline if the receivables are not recovered, i.e., the client gets total credit protection. In this
type of factoring, all the components of service viz., short-term finance, administration of
sales ledger and credit protection are available to the client.

3. Advance Factoring and Maturity Factoring : Under this type of factoring


arrangement, the factor does not make any advance or pre-payment. The factor pays the
client either on a guaranteed payment date or on the date of collection from the customer.
This is as opposed to ‘Advance factoring’ where the factor makes prepayment of around 80%
of the invoice to the client.

4. 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 pre-
payment to the client against the purchase of accounts receivables and collects interest
(service charges) for the period extending from the date of pre-payment to the date of
collection. The sales ledger administration and collection are carried out by the client.

Other types of factoring not popular in India :

5. Bulk/Agency Factoring : This type of factoring is basically used as a method of financing


book debts. Under this the client continues to administer credit and operate sales ledger.
The factor finances the book debts against bulk either on recourse or without recourse. This
sort of factoring become popular with the development of mini-computers market where
marketing and credit management was not a problem but the firms needed temporary
financial accommodation. Those companies which have good systems of credit
administration, but need finances, prefer this form of factoring.

6. Non-notification Factoring : In this type of factoring, customers are not informed about
the factoring agreement. It involves the factor keeping the accounts ledger in the name of a
sales company to which the client sells his book debts. It is through this company that the
factor deals with the client’s customers. The factor performs all his usual functions without a
disclosure to customers that he owns the book debts. This type of factoring is available in the
UK to financially strong companies.

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