ASSIGNMENT

OF FACTORING

SUBMITTED TO:- SUBMITTED By:-

Prof... Dhiraj Sharma Jagjeet Singh

Jatinder Garg
MBA 3rd (A)

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.

Flow Chart of Factoring

 credit sale of
goods
Customer Client
Invoic
e

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

Payment up to
80% initially

Factor

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.

Credit rating is not mandatory. But the factoring companies

usually carry out credit risk analysis before entering into the

agreement.

5. 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.

6. 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).

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.

Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com
SBI Factors and Commercial Services Pvt. Ltd:
http://www.sbifactors.com

The Hongkong and Shanghai Banking Corporation Ltd:

http://www.hsbc.co.in/in/corp/factserv.htm

Foremost Factors Limited: http://www.foremostfactors.net

Global Trade Finance Limited: http://www.gtfindia.com

Export Credit Guarantee Corporation of India Ltd:

http://www.ecgcindia.com

Citibank NA, India: http://www.citibank.co.in

Small Industries Development Bank of India (SIDBI):

http://www.sidbi.in/fac.asp

Domestic Factoring & International Factoring

Factoring is a service that covers the financing and collection of

account receivables in domestic and international trade. It is an

ongoing arrangement between the client and Factor, where

invoices raised on open account sales of goods and services are

regularly assigned to "the Factor" for financing, collection and

sales ledger administration. The buyer and the seller usually have

long term relationships. The client sells invoiced receivables at a

discount to the factor to raise finance for working capital

requirement. The factor may or may not accept the incumbent

credit risk. Factoring enables companies to sell their outstanding

book debts for cash.

The factor operates by buying from the selling company their

invoiced debts. These are purchased, usually with credit protection,

by the factor who then will be responsible for all credit control,

collection and sales accounting work. Thus the management of the

company may concentrate on production and sales and need not

concern itself with non-profitable control and sales accounting

matters.

By obtaining payment of the invoices immediately from the factor,

usually up to 80% of their value the company's cash flow is
improved. The factor charges service fees that vary with interest
rates in force in the money market.

The world's local bank

Trade & Factoring Services

HSBC currently offers both domestic and international factoring
products.

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

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 payment.

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.
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.

 Function of a factor

1. Administration of sales ledger

The factor maintain sales ledger in respect of each client when the sales

transaction takes place an invoice is prepared in duplicate by the client,

One copy is given to customer and second copy is sent to the factor.

Entries are made in the ledger on open item method. Each recipt is

matched against the specific invoice.On any given date the customer

account indicate the various open invoices outstanding .Periodec reports

are sent by factor to the clint with respect to current status of

transaction,the periodicity of report is decided. Thus the entire sales

ledger administration responsibility of the client gets transferred to factor.

2. Collection of Recivables

The main function of the factor is to collect the receivable on the behalf

of the client and to relieve him from all the botherations problems

associated with the collection . This way the clint can concentrate on
other major areas of his business on one hand and reduce the cost of

collection by way of saving in labour time and efforts on the other hand.

The factor possesses trained and experienced personal, sophisticated

infrastructure and improve technology which helps him to make timely

demands on the debtors to make payments.

3. Provision of Finance

Finance which is the life blood of a business, is made available easily by

the factor to the client. A factor purchased the book debts of his client and

debts are assigned in favour of the factor .75%to 80% of the assigned

debts is given as advance to the client by the factor.

4. Protection Against Risk

This sevices is provided where the debts are factored without resources.

The factor fixes the credit limit in respect of approved customers. Within

this limit the factor undertakes to purchase all trade debts and assumes

risk of default in payment by the customers. The factor not only relives

the client from the collection work but also advises the client on the

creditworthiness of potential customers . Thus the factor helps the client

in adopting better credit control policy. The credit standing of the

customers is assessed by the factors on the basis of information collected

from credit rating reports, bank reports, trade reference, financial

statement analysis and by calculating the important ratios in respect of

liquidity and probility position.

5. Advisory Services

These services arise out of theclose relationship between a factor and a

client. Since the factor have better knowledge and wide experience in

field of finance, and possess extensive credit information about

customers standing they provide various advisory services on the matters

relating to:

I. Customer’s preferences regarding the clients products.

II. Changes in marketing polices of the competitors.

III. Suggest improvements in the procedures adopted for invoicing,

delivery and sales return.

IV. Helping the clients for raising finance from banks /financial

institutions, etc.
 Discount Rate

In the beginning, the factoring industry had some relatively high discount

rates due to heavy expenses caused by costly litigation battles and limited

access to traditional investors. However, once state and federal legislation

was enacted, the industry’s interest rates decreased dramatically. There is

much confusion with the terminology “discount rate” because the term is

used in different ways. The discount rate referred to in a factoring

transaction is similar to an interest rate associated with home loans, credit

cards and car loans where the interest rate is applied to the payment stream

itself. In a factoring transaction, the factoring company knows the payment

stream they are going to purchase and applies an interest rate to the payment

stream itself and solves for the funding amount, as though it was a loan.

Discount rates from factoring companies to consumers can range anywhere

between under 9% up to over 18% but usually average somewhere in the

middle. Factoring discount rates can be a bit higher when compared to home

loan interest rates, due to the fact the factoring transactions are more of a

boutique product for investors opposed to the mainstream collateralized

mortgage transactions. One common mistake in calculating the discount rate

is to use “elementary school math” where you take the funding/loan amount

and divide it by the total price of all the payments being purchased. Because

this method disregards the concept of time (and the time value of money),

the resulting percentage is useless. For example, the court in In Re

Henderson Receivables Origination v. Campos noted an annual discount rate

of 16.8% where the annuitant received $36,500 for the assignment of

payments totaling $63,364.94 over 84 months (two monthly payments of

$672.32 each, beginning September 30, 2006 and ending on October 31,

2006; eighty-two monthly payments of $692.49 each, increasing 3% every

twelve months, beginning on November 30, 2006 and ending on August 31,

2013). However, had the court in Henderson Receivables Origination

applied the illogical formula of discounting from “elementary school math”

($36,500/ $63,364.94), the discount rate would have been an astronomical

(and nonsensical) 61%. [17]

 SBI Factors and Commercial Services Pvt Ltd (SBI
FACTORS)

SBI Factors, a subsidiary of State bank of India (SBI) is one of the

leading factoring companies in India with an asset base of Rs.
700.10 crores as on 30.09.2005. It was established in February
1991 with the primary objective to provide domestic factoring
services to Small and Medium Enterprises (SMEs). Factoring is a
Collection and finance service designed to improve the cash flow
position of SMEs by turning their credit invoices into ready cash.
The major strength of the company is that it has put in place a
technology driven platform for offering integrated receivables
management. SBI and its Associates Banks hold 70% stake in SBI
Factors.

SBIF offers Domestic Factoring With Recourse and Without

Recourse. Purchase Bill Factoring, Factoring of Usance Bills
Under LC, Channel Financing of Dealers / Distributors and Export
Factoring Facilities. All its products have been well received by its
clients.

SBIF has ten branches all over the country and it has plans to open
three more branches during the year. It has achieved a turnover of
Rs. 1489.54 Crores with Prepayment Outstanding of Rs. 459.35
crores for the year ended 31.03.2005. The profit before tax was Rs.
9.64 crores and PAT Rs. 6.12 Crores for the year 2004-05. It has
recorded a NIL NPA position as at 31.03.2005. It has declared a
dividend of 8% during the year 2005. It has a market share of
40.30% as on 30.09.2005.