FACTORING

SUBMITTED BY:
VIVEK SHARMA
 INTRODUCTION
Factoring, as a fund based financial service, provides resources to
finance receivables as well as facilitates the collection of receivables.
The word “Factor” has been derived from the Latin word “Facere”
which means To make or Do, i.e. To get things done.
Factoring is a continuing legal relationship between a financial
institution (the factor) and a business concern (the client), selling
goods or providing services to trade customers (the customers) on
open account basis whereby the Factor purchases the client’s book
debts (accounts receivables) either with or without recourse to the
client and in relation thereto controls the credit extended to customers
and administers the sales ledgers’.
DEFINITIONS
It is an arrangement under which the factor purchase the account
receivables and makes immediate cash payment to suppliers. The
factor undertake the responsibility of collecting the dues from the
buyer and hence assumes risks.

Factoring is a system designated to eliminate the payment risk in

overseas sales and ensure that the seller receive prompt settlement.

Factoring is a service of financial nature involving the conversion

of credit bills into cash.
 Process of Factoring

credit sale of
goods
Customer Client
(Buyer) Invoice (Seller)

Pays the balance

amount
Pays the amount (In recourse
type customer pays through Submit invoice
client) copy

Payment up to
80% initially

Factor
FUNCTION OF FACTORING
1. FINANCE
2. DEBT ADMINISTRATION
3. CREADIT RISK
4. ADVISORY SERVICE
TYPES OF FACTORING
1. Notified and Undisclosed Factoring
2. Recourse and Non Recourse Factoring
3. Advance and Maturity Factoring
4. Bank Participation Factoring
5. Invoice Factoring
6. Buyer-Based, Seller-Based and Selective Factoring
7. With Credit and Without Credit Factoring
8. Export or International Factoring
 1.NOTIFIED AND UNDISCLOSED FACTORING

In case of notified factoring, the customer is informed about the

assignment of the debt to the factoring agent and is also asked to
pay the dues to the factor instead of to the firm. On the other hand
in the undisclosed factoring, the factoring arrangement is not
disclosed to the customer but the customer is required to make the
payment to the changed address. This is also known as non-notified
factoring or confidential factoring.
2. RECOURSE AND NON- RECOURSE FACTORING
In recourse factoring ‘the factor purchase the receivable on the
condition that the loss arising on account of irrecoverable
receivable will be borne by the client, while in non-recourse
factoring the bad debts are borne by t he factoring agents. Since the
factor bears the loss arising on account of irrecoverable debt, the
factor charges a higher commission.
3. ADVANCE AND MATURITY FACTORING

In case of advance factoring, the factor provides an advance value

of receivables factored and the balance is paid on collection or on
the guaranteed payment date. Where as in maturity factoring, the
factor makes the payment on a guaranteed payment date or on the
date of collection.
4.BANK PARTICIPATION FACTORING
Under this arrangement, the bank finances against the reserves
which is maintained by the factor on which the firm creates a
floating charges on the factoring reserves in favor of bank and
borrows against these reserve
5. INVOICE FACTORING
This form of factoring is not considered as an integral part of the
present day factoring system because it does not carry the service
element of factoring. Under this type of factoring the debts due to
 CONT…………….
The client are purchased by the factor who thus provides improved
liquidity under which the supplier’s position becomes very
comfortable.
6. BUYER-BASED, SELLER- BASED AND SELECTIVE FACTORING
Buyer-based factoring means that the factor would maintain a list of
buyers and would be factored without recourse to the seller.
Whereas in seller-based factoring, the factor would prefer seller-
based factoring with recourse and without recourse. Seller-based
factoring is known as selective factoring where the seller is
restricted to sell to the approved buyer
7. WITH CREDIT AND WITHOUT CREDIT FACORING
The buyer can make a contract in favor of seller that the seller does
not assign the credit to any third party. Under such circumstances,
the factor is unable to register his power of attorney and has to trust
the seller to remit the money to him after realization
8. EXPORT FACTORING

This is also known as international factoring or cross border

factoring.
Export factoring houses deal with expert sales and provide financial
service, collection service, advisor service , and service for
completing legal formalities pertaining to export. Generally, export
factoring is quite helpful to small exporters and new entrants to
export business in India.
 ADVANTAGES OF FACTORING
1. Through factoring, the client gets immediate cash which reduces the
operating cycle and increase the turnover.
2. As the factor takes all the responsibility of maintaining sales ledger
administration, credit control, and debt collection, the collection is
relieved from the administrative burden.
3. As the factor provides instant cash to the client against credit sales,
the client can drive benefit from the cash discount by making
prompt payment for this purchases. This will substantially reduce
purchase cost and improve profitability.
4. By off-loading the administration, the client has more time for
planning, running and improving the business and exploiting
opportunities.
5. Factoring ensure a perfect debtor turnover and improve the
profitability of the client by avoiding the risk of bad debts.
DISADVANTAGES OF FACTORING
1. Image of the client may suffer as engaging a factoring agency is not
considered a good sign of efficient management.
2. Factoring may not be of much use where companies or agents have
one time sales with the customers.
3. Factoring increases cost of finance and thus cost of running the
business.
4. If the client has cheaper means of finance and credit (where goods
are sold against advance payment), factoring may not be useful.
FACTORING AND PROFIT & LOSS ACCOUNT

The benefits of factoring in term of the profit an loss account are

analyzed as under:
1) The factor performs basis function like administration of seller’s sales
ledger, credit control, collection of due’s etc. this saves the
administration costs.
2) The factor by providing payments on the purchase of receivables
contrasts the length of operating cycle period and reduces the
working capital need. This saves the interest on capital.
3) The improved liquidity position enables the firm to honour its
obligations without and delay. The improved credit standing helps
the firm to get the benefits of lower purchase price, longer credit
period from suppliers, trade discount on bulk purchase, cash discount
on early payment, better market standing, quicker sanction of loans
and advances and better terms and condition while borrowing etc.
 COST OF FACTORING
The cost of factoring includes:
1. Interest on advance extended by the factor.
2. Commission /fee for his service interest rate ranges between 2-5%
over and above the prime rate of interest.
3. The commission is usually in the range of 2.5% to 3% on the gross
value of invoices. In fact, the factoring commission depend on the
total volume of receivables, the size of individual receivables, and
the quality of receivables.
The following are the important assumption made in constructing
the statement:
1. The average receivables of the firm are equal to two months sale
2. All sales are on credit basis
3. Cost of goods sold is equal to 60% of the sales.
4. The bad debts loss percentage is 15% of gross value of sales
CONT……..
5. Administration cost (which includes credit department expenses of
Rs.2,00,000) and selling costs are assumed to be Rs. 1,00,000 and
16,00,000 respectively.
6. The interest charged by the factor as well as by the other financial
institution on advance is assumed to be 18% per annum.
7. The margin money is 10%.
 FACTORING IN INDIA
Factoring service in of recent origin in India. It owes its genesis in the
recommendations of the Kalyansundaram Study Group appointed by the
RBI in 1989. Pursuant to the acceptance of these recommendations, the
RBI issued guidelines for factoring service in 1990. The first factoring
company- SBI factor and commercial ltd. Started operation in April
1991. This section highlights the importance aspects of the factoring
service in India.
Recommendations of Kalyansundram committee
(a) Taking all the relevant facts into account, there is sufficient scope for
introduction of factoring services in India which would be
complementary to the service provide by banks.
(b) The introduction of export factoring service would provide an additional
facility to exporters.
(c) On the export front, there would be a fairly good availment of various
services offered by exporter factor.
CONT…….
(d) With a view to attaining a balanced dispersal of risk, factor should
offer their to all industries and all sectors in the company.
(e) The pricing of various services by factors would essentially
depends upon the cost of funds. Factors should attempt a mix from
among the various sources of funds to keep the cost of funds as how
as possible, in any case not exceeding 12.5 per annum, so that a
reasonable spread is available.
(f) The RBI could consider allowing factoring organizations to raise
funds from the Discount and Finance House of India Ltd. as also
other approved financial institutions, against their usance
promissory notes covering receivables factor by them, on the lines
of revised procedure under bills rediscounting scheme.
(g) The price for financing services would be around 16% per annum
and the aggregate price for all order services may not exceed 2.5%
to 3% of the debts services.
CONT………….
(h) In the beginning only select promoters institutions/groups of
individuals with good track records in financial services and
competent management should be permitted to enter into this new
field.
(I) Initially the organizations may be promoted on a zonal basis.
(j) Factoring activities could perhaps be taken up by the small
Industries Development Bank of India, preferably in association
with one or more commercial banks.
(k) The business community should first be educated through the bank
branches about the nature and scope of these services and the
benefits accruing there from.
(l) An element of competition is absolutely necessary for ensuring
satisfactory service to the exporters and they should have the
opportunity to make their own choice regarding the factors whose
services to avail of.