FUNCTIONS

Purchase and collection of debt

Sales ledger management

Credit investigation and undertaking of credit risk

Provision of finance against debts

Rendering consulting services

TYPES OF FACTORINGRecourse and Non-recourse Factoring
Under a recourse factoringarrangement, the factor has recourse to the client (firm)
if the debt purchased/receivablesfactored turns out to be irrecoverable. If the
customer defaults in payment, the client
hast o m a k e s g o o d t h e l o s s i n c u r r e d b y t h e f a c t o r . T h e f a c t o r
c h a r g e s t h e c l i e n t f o r maintaining the sales ledger and debt collection
services and also for the interest for the period on the amount drawn by
the client.The factor does not have the right of recourse in the case of non-recourse
factoring.The loss arising out of irrecoverable receivables is borne by him,
as a compensationwhich he charges a higher commission.
Advance and Maturity Factoring
A drawing limit, as a pre-payment,is made available by the factor to the
client as soon as the factored debts are approved.The client has to pay
interest on the advance between the date of such payment and the date of
actual collection from the
customers.T h e m a t u r i n g f a c t o r i n g i s a l s o k n o w n a s C o l l e c t i o n
f a c t o r i n g . U n d e r s u c h arrangements, the factor does not make a prepayment to the client. The payment is madeeither on the guaranteed payment date
or on the date of collection.

Full Factoring
This is the most comprehensive form of factoring combining thefeatures of almost
all the factoring services specially those of non-recourse and
advancef a c t o r i n g . F u l l f a c t o r i n g p r o v i d e s t h e e n t i r e s p e c t r u m o f s e r

v i c e s ( c o l l e c t i o n , c r e d i t protection, sales ledger administration and short

term finance).
Disclosed and Undisclosed Factoring
In disclosed factoring, the nameof the factor is disclosed in the invoice by the
supplier-manufacturer of the goods askingthe buyer to make payment to the
factor. The supplier may continue to bear the risk of non-payment by the
buyer without passing it on to the factor.The name of the factor is not
disclosed in the invoice in undisclosed factoringalthough the factor
maintains the sales ledger of the supplier manufacturer. The
entirerealization of the business transaction is done in the name of
Supplier Company but allcontrol remains with the factor. He also provides
short-term finance against sales invoice.
Domestic and Export/Cross-Border/International Factoring
In the domestic factoring, the three parties involved, namel
y , c u s t o m e r ( b u y e r ) , c l i e n t ( s e l l e r- s u p p l i e r ) a n d f a c t o r ( f i n a n c i a l
i n t e r me d i a r y ) a r e d o m i c i l e d i n t h e s a m e country.The process of export
factoring is almost similar to domestic factoring except inrespect of the
parties involved. There are usually four parties involved in crossborder factoring transaction. They are: exporter (client), importer (customer),
export factor andimport factor.
ADVANTAGESBenefits of Factoring to Clients
1)
Under the factoring arrangement the client receives prepayment upto 80-90 percent
of the invoice value immediately and the balance amount after thematurity period.
This helps the client to improve cash flow position which

enables him to have better flexibility in managing working capital funds inan
efficient and effective manner.
2)
If the client avails the services of the factor in respect of sales
ledger a d m i n i s t r a t i o n a n d c o l l e c t i o n o f r e c e i v a b l e s , h e n e e d
n o t h a v e a n y a d m i n i s t r a t i v e s e t u p f o r t h i s p ur p o s e . N a t u r a l l y
this will result into as u b s t a n t i a l s a v i n g i n t i m e a n d c o s t o f m a
i n t a i n i n g o w n s a l e s l e d g e r administration and collecting
receivables from the customer. Thus, it willreduce administrative cost and
time.
3)

W h e n w i t h o u t r e c o ur s e f a c t o r i n g a r r a n g e me n t i s m a d e , t h e c l i e n t
cane l i m i n a t e t h e l o s s e s o n a c c o u n t o f b a d d e b t s . T h i s w i l l h
e l p h i m t o concentrate more on maximizing production and sales. Thus, it will
result inincrease in sales, increase in business and increase in profit.
4)
T h e c l i e n t c a n a v a i l a d v i s o r y s e r v i c e s f r o m t h e f a c t o r by v i r t u e o f
h i s expertise and experience in the areas of finance and marketing. This
willhelp the client to improve efficiency and productivity of his
organization.B e s i d e s t h i s , w i t h t h e h e l p o f d a t a b a s e , t h e f a c t o r c a n
r e a d i l y p r o v i d e information regarding product design/mix, prices, market
conditions etc., tothe client which could be useful to him for business
decisions.The above mentioned benefits will accrue to the client provided
he develops a better business relationship with the factor and both of them have
mutual trust ineach other.
Disadvantages of Factoring
1) Image of the client may suffer as engaging a factoring agency is not considereda
good sign of efficient management.2) Factoring may not be of much use
where companies or agents have one timesales 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
soldagainst advance payment), factoring may not be useful.

Introduction
Receivables constitute a significant portion of current assets of a firm. But, for
investment in receivables, a firm has to incur certain costs such as costs of
financing receivables and costs of collection from receivables. Further, there is a risk
of bad debts also. It is, therefore, very essential to have a proper control and
management of receivables. In fact, maintaining of receivables poses two types of
problems; (i) the problem of raising funds to finance the receivables, and (it) the
problems relating to collection, delays and defaults of the receivables. A small firm
may handle the problem of receivables management of its own, but it may not be
possible for a large firm to do so efficiently as it may be exposed to the risk of more
and more bad debts. In such a case, a firm may avail the services of specialised
institutions engaged in receivables management, called factoring firms. At the
instance of RBI a Committee headed by Shri C. S. Kalyan Sundaram went into the
aspects of factoring services in India in 1988, which formed the basis for
introduction of factoring services in India. SBI established, in 1991, a subsidiary-SBI
Factors Limited with an authorized capital of Rs. 25 crores to undertake factoring
services covering the western zone

Meaning and Definition Factoring may broadly be defined as

the relationship, created by an agreement, between the seller of goods/services and
a financial institution called .the factor, whereby the later purchases the receivables
of the former and also controls and administers the receivables of the former.
Factoring may also be defined as a continuous relationship between financial
institution (the factor) and a business concern selling goods and/or providing service
(the client) to a trade customer on an open account basis, whereby the factor
purchases the clients book debts (account receivables) with or without recourse to
the client - thereby controlling the credit extended to the customer and also
undertaking to administer the sales ledgers relevant to the transaction. The term
factoring has been defined in various countries in different ways due to nonavailability of any uniform codified law. The study group appointed by International
Institute for the Unification of Private Law (UNIDROIT), Rome during 1988
recommended, in simple words, the definition of factoring as under: Factoring
means an arrangement between a factor and his client which includes at least two
of the following services to be provided by the factor: Finance
Maintenance of accounts
Collection of debts
Protection against credit risks
The above definition, however, applies only to factoring in relation to supply of
goods and services in respect of the following
i.

To trade or professional debtors

ii. Across national boundaries

When notice of assignment has been given to the debtors.

The development of factoring concept in various developed countries of the

world has led to some consensus towards defining the term. Factoring can
broadly be defined as an arrangement in which receivables arising out of sale of
goods/ services are sold to the factor as a result of which the title to the
goods/services represented by the said receivables passes on to the factor.
Hence the factor becomes responsible for all credit control, sales accounting
and debt collection from the buyer (s).

Glossary of Terminology
The common terminology used in a factoring transaction are as follows: i. Client
He is also known as supplier. It may be a business institution supplying the
goods/services on credit and availing of the factoring arrangements. ii.
Customer A person or business organisation to whom the goods/ services have
been supplied on credit. He may also be called as debtor. iii. Account
receivables Any trade debt arising from the sale of goods/ services by the client
to the customer on credit. iv. Open account sales Where in an arrangement
goods/ services are sold/supplied by the client to the customer on credit without
raising any bill of exchange or promissory note. v. Eligible debt Debts, which are
approved by the factor for making prepayment. vi. Retention Margin maintained
by the factor. vii. Prepayment An advance payment made by the factor to the
client up to a certain percent of the eligible debts.

Nature of Factoring
Factoring is a tool of receivable management employed to release funds tied up
in credit extended to customers. 1. Factoring is a service of financial nature
involving the conversion of credit bills into cash. Accounts receivables, bills
recoverable and other credit dues resulting from credit sales appear in the
books of account as book credits.
2. The risk associated with credit are taken over by the factor which purchases
these credit receivables without recourse and collects them when due. 3. A
factor performs at least two of the following functions: i. Provides finance for the
supplier including loans and advance payments. ii. Maintains accounts, ledgers
relating to receivables. iii. Collects receivables. iv. Protects risk of default in
payments by debtors. 4. A factor is a financial institution which offers services
relating to management and financing of debts arising out of credit sales. It acts
as another financial intermediary between the buyer and seller. 5. Unlike a
bank, a factor specialises in handling and collecting receivables in an efficient
manner. Payments are received by the factor directly since the invoices are
assigned in favor of the factor. 6. Factor is responsible for sales accounting, debt
collection and credit control protection from bad debts, and rendering of
advisory services to their clients. 7. Factoring is a tool of receivables
management employed to release funds tied up in credit extended to customers
and to solve the problems relating to collection, delays and defaults of the
receivables

Mechanism of Factoring
Factoring business is generated by credit sales in the normal course business.
The main function of factor is realisation of sales. Once the transaction takes
place, the role of factor step in to realise the sales/collect receivables. Thus,
factor act as a intermediary between the seller and till and sometimes along
with the sellers bank together. The mechanism of factoring is summed up as
below: i. An agreement is entered into between the selling firm and the firm.
The agreement provides the basis and the scope understanding reached
between the two for rendering factor service. ii. The sales documents should
contain the instructions to make payment directly to the factor who is assigned
the job of collection of receivables. iii. When the payment is received by the
factor, the account of the firm is credited by the factor after deducting its fees,
charges, interest etc. as agreed. iv. The factor may provide advance finance to
the selling firm conditions of the agreement so require.

Parties to the Factoring

There are basically three parties involved in a factoring transaction. 1. The
buyer of the goods. 2. The seller of the goods 3. The factor i.e. financial
institution. The three parties interact with each other during the purchase/ sale
of goods. The possible procedure that may be followed is summarised below.

The Buyer
1. The buyer enters into an agreement with the seller and negotiates the terms
and conditions for the purchase of goods on credit. 2. He takes the delivery
of goods along with the invoice bill and instructions from the seller to make
payment to the factor on due date. 3. Buyer will make the payment to the
factor in time or ask for extension of time. In case of default in payment on
due date, he faces legal action at the hands of factor

The Seller

.
1. The seller enters into contract for the sale of goods on
credit as per the purchase order sent by the buyer stating various terms and
conditions. 2. Sells goods to the buyer as per the contract. 3. Sends copies of
invoice, delivery challan along with the goods to the buyer and gives
instructions to the buyer to make payment on due date. 4. The seller sells the
receivables received from the buyer to a factor and receives 80% or more
payment in advance. 5. The seller receives the balance payment from the
factor after paying the service charges.

The Factor

1.The factor enters into an agreement with the seller for rendering factor services
i.e. collection of receivables/debts.
2. The factor pays 80% or more of the amount of receivables copies of sale
documents. 3. The factor receives payments from the buyer on due dates and pays
the balance money to the seller after deducting the service charges.

Types of Factoring
A number of factoring arrangements are possible depending upon the
agreement reached between the selling firm and the factor. The most common
feature of practically all the factoring transactions is collection of receivables
and administration of sale ledger. However, following are some of the important
types of factoring arrangements.

1. Recourse and Non-recourse Factoring In a recourse factoring

arrangement, the factor has recourse to the client (selling firm) if the receivables
purchased turn out to be bad, Let the risk of bad debts is to be borne by the
client and the factor does not assume credit risks associated with the
receivables. Thus the factor acts as an agent for collection of bills and does not
cover the risk of customers failure to pay debt or interest on it. The factor has a
right to recover the funds from the seller client in case of such defaults as the
seller takes the risk of credit and creditworthiness of buyer. The factor charges
the selling firm for maintaining the sales ledger and debt collection services and
also charges interest on the amount drawn by the client (selling firm) for the
period. Whereas, in case of non-recourse factoring, the risk or loss on account of
non-payment by the customers of the client is to be borne by the factor and he
cannot claim this amount from the selling firm. Since the factor bears the risk of
non-payment, commission or fees charged for the services in case of
nonrecourse factoring is higher than under the recourse factoring. The additional
fee charged by the factor for bearing the risk of bad debts/non-payment on
maturity is called del credere commission.

2. Advance and Maturity Factoring

3. Under advance factoring arrangement, the factor pays only a certain

percentage (between 75 % to 90 %) of the receivables in advance to the client,

the balance being paid on the guaranteed payment date. As soon as factored
receivables are approved, the advance amount is made available to the client by
the factor. The factor charges discount/interest on the advance payment from
the date of such payment to the date of actual collection of receivables by the
factor. The rate of discount/interest is determined on the basis of the
creditworthiness of the client, volume of sales and prevailing short-term rate.
Sometimes, banks also participate in factoring transactions. A bank agrees to
provide an advance to the client to finance a part say 50% of the (factored
receivables - advance given by the factor). For example : Assume total value of

the factored debt/receivable is Rs. 100 A factor finances 80 % of the debt. Rs. 80
Balance value of debt Rs. 20 Say, bank finances 50% of the balance i.e. Rs. 10.
Thus, the factor and the bank will make a pre-payment of Rs. 90 (i.e. 90% of the
debt) and the clients share is only 10% of the investment in receivables. In case
of maturity factoring, no advance is paid to client and the payment is made to
the client only on collection of receivables or the guaranteed payment data as
the case may be agreed between the parties. Thus, maturity factoring consists
of the sale of accounts receivables to a factor with no payment of advance funds
at the time of sale.

4. Conventional or Full Factoring

5. Under this system the factor performs almost all services of collection of
receivables, maintenance of sales ledger, credit collection, credit control and
credit insurance. The factor also fixes up a draw limit based on the bills
outstanding maturitywise and takes the corresponding risk of default or credit
risk and the factor will have claims on the debtor as also the client creditor. It is
also known as Old Line Factoring. Number of other variety of services such as
maturity-wise bills collection, maintenance of accounts, advance granting of
limits to a limited discounting of invoices on a selective basis are provided. In
advanced countries, all these methods are popular but in India only a beginning
has been made. Factoring agencies like SBI Factors are doing full factoring for
good companies with recourse.

6. 4. Domestic and Export Factoring The basic difference

between the domestic and export factoring is on account of the number of
parties involved. In the domestic factoring three parties are involved, namely:
The import factor acts as a link between export factor and the importer helps in
solving the problem of legal formalities and of language.

7. 1. Customer (buyer)
8. 2. Client (seller)
9. 3. Factor (financial intermediary)

All the three parties reside in the same country. Export factoring is also termed as
cross-border/international factoring and is almost similar to domestic factoring
except that there are four parties to the factoring transaction. Namely, the exporter
(selling firm or client), the importer or the customer, the export factor and the
import factor. Since, two factors are involved in the export factoring, it is also called
two-factor system of factoring.
Two factor system results in two separate but inter-related contracts:1. between the exporter (client) and the export factor
2. export factor and import factor.

The import factor acts as a link between export factor and the importer helps in
solving the problem of legal formalities and of language. He also assumes
customer trade credit risk, and agrees to collect receivables and transfer funds
to the export factor in the currency of the invoice. Export/International factoring
provides a non-recourse factoring deal. The exporter has 100 % protection
against bad debts loss arising on account of credit sales

5. Limited Factoring
Under limited factoring, the factor discounts only certain invoices on selective
basis and converts credit bills into cash in respect of those bills only

6. Selected Seller Based Factoring The seller sells all his accounts
receivables to the factor along with invoice delivery challans, contracts etc. after
invoicing the customers. The factor performs all functions of maintaining the
accounts, collecting the debts, sending reminders to the buyers and do all
consequential and incidental functions for the seller. The sellers are normally
approved by the factor before entering into factoring agreement.

7. Selected Buyer Based Factoring The factor

first of all selects the buyers on the basis of their goodwill and creditworthiness
and prepares an approved list of them. The approved buyers of a company
approach the factor for discounting their purchases of bills receivables drawn in
the favour of the company in question (i.e. seller). The factor discounts the bills
without recourse to seller and makes the payment to the seller.

8. Disclosed and Undisclosed Factoring

In disclosed factoring, the name of the factor is mentioned in the invoice by the
supplier telling the buyer to make payment to the factor on due date. However,
the supplier may continue to bear the risk of bad debts (i.e. non-payments)
without passing to the factor. The factor assumes the risk only under
nonrecourse factoring agreements. Generally, the factor lays down a limit within
which it will work as a non-recourse. Beyond this limit the dealings are done on
recourse basis i.e. the seller bears the risk. Under undisclosed factoring, the
name of the factor is not disclosed in the invoice. But still the control lies with
the factor. The factor maintain sales ledger of the seller of goods, provides shortterm finance against the sales invoices but the entiretransactions take place in
the name of the supplier company (seller).

Functions of a Factor

The purchase of book debts or receivables is central to the function of factoring

permitting the factor to provide basic services such as :
1. Administration of sellers sales ledger.
2. Collection of receivables purchased.
3. Provision of finance.
4. Protection against risk of bad debts/credit control and credit protection.
5. Rendering advisory services by virtue of their experience in financial dealings
with customers.
These are explained as under.

1. Administration of Sales Ledger

The factor assumes the entire responsibility of administering sales ledger.
The factor maintains 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 receipt is matched against
the specific invoice. On any given date, the customer account indicates the
various open invoices outstanding. Periodic reports are sent by factor to the
client with respect to current status of receivables and amount received from
customers. Depending upon the volume of transactions, the periodicity of
report is decided. Thus, the entire sales ledger administration responsibility of
the client gets transferred to the factor. He performs the following functions
with regard to the administration of sales ledger: i. He ensures that invoices
raised represent genuine trade transactions in respect of goods sold or
services provided. ii. He updates the sales ledger with latest invoices raised
and cash received. iii. He ensures that monthly statements are sent to the
debtors, efforts are made to collect the dues on the due dates through an
efficient mechanism of personal contacts, issuance of reminders, telephone
messages etc. iv. He remits the retention to the clients after collection of the
dues. Where the factoring is operating on Fixed Maturity Period (FMP) basis,
the factor is to ensure that the client is paid the retention money at the
expiry of the said period. v. He establishes close links with the client and the
customers to resolve the various disputes raised in respect of quantity or
quality of the goods/services supplied besides the unauthorised discounts
claimed or deducted by the debtors while making payment. vi. He reviews
the financial strength of the debtors at periodic intervals to ensure
collectability of debts. vii. He submits at periodic intervals the reports
containing information as to the details of overdue unpaid invoices, disputes,
legal cases etc. to the client

2. Collection of Receivables The factor helps the client in

adopting better credit control policy. The main functions of a factor is to
collect the receivables on behalf of the client and to relieve him from all the
botherations/problems associated with the collection. This way the client can
concentrate on other major areas of his business on one hand and reduce the
cost of collection by way of savings in labor, time and efforts on the other
hand. The factor possesses trained and experienced personnel, sophisticated
infrastructure and improved technology which helps him to make timely
demands on the debtors to make payments.

3. Provision of Finance Finance, which is the lifeblood of a business,

is made available easily by the factor to the client. A factor purchases the
book debts of his client and debts are assigned in favor of the factor. 75% to
80 percent of the assigned debts is given as an advance to the client by the
factor. a. Where an agreement is entered into between the client (seller) and
the c factor for the purchase of receivables without recourse, the factor
becomes responsible to the seller on the due date of the invoice whether or
not the buyer makes the payment to the factor. b. Where the debts are
factored with recourse- the client has to refund the full finance amount
provided by the factor in case the buyer fails to make the payment on due
date.

4. Protection Against Risk This service is provided where the debts

are factored without recourse. The factor fixes the credit limits (i.e. the limit up to
which the client can sell goods to customers) in respect of approved customers.
Within these limits the factor undertakes to purchase all trade debts and assumes
risk of default in payment by the customers. The factor not only relieves 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 customer 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 profitability position.

5. Advisory Services These services arise out of the close relationship

between a factor and a client. Since the factors 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 : a. Customers preferences regarding the clients products. b. Changes in
marketing policies/strategies of the competitors. c. Suggest improvements in the
procedures adopted for invoicing, delivery and sales return. d. Helping the client for
raising finance from banks/financial institutions, etc.
The factor provides his client with a periodical statement on the sanctioned limit,
utilised credit and balance outstanding. The following data is provided regularly: a.
List of book debts taken over b. Book debts realised c. Age-wise classification of the

debts d. Debts collected and due for collection e. Debts purchased with recourse or
without recourse etc.

Advantages of Factoring Factoring is becoming popular all over the

world on account of various services offered by the institutions engaged in it.
Factors render services ranging from bill discounting facilities offered by the
commercial banks to total take over of administration of credit sales including
maintenance of sales ledger, collection of accounts receivables, credit control,
protection from bad debts, provision of finance and rendering of advisory services to
their clients. Thus factoring is a tool of receivables management employed to
release the funds tied up in credit extended to customers and to solve problems
relating to collection, delays and defaults of the receivables. A firm that enters into
factoring agreement is benefited in a number of ways, some of the important
benefits are outlined below: 1. The factors provides specialised services with regard
to sales ledger administration and credit control and relieves the client from the
botheration of debt collection. He can concentrate on the other major areas of his
business and improve his efficiency. 2. The advance payments made by the factor
to the client in respect of the bills purchased increase his liquid resources. He is able
to meet his liabilities as and when they arise thus improving his credit standing
position before suppliers, lenders and bankers. The factors assumption of credit risk
relieves him from the tension of bad debt losses. The client can take steps to reduce
his reserve for bad debts. 3. It provides flexibility to the company to decide about
extending better terms to their customers. 4. The company itself is in a better
position to meet its commitments more promptly due to improved cash flows. 5.
Enables the company to meet seasonal demands for cash whenever required. 6.
Better purchase planning is possible. Availability of cash helps the company to avail
cash discounts on its purchases. 7. As it is an off balance sheet finance, thus it does
not affect the financial structure. This would help in boosting the efficiency ratios
such as return on asset etc. 8. Saves the management time and effort in collecting
the receivables and in sales ledger management. 9. Where credit information is also
provided by the factor, it helps the company to avoid bad debts. 10. It ensures
better management of receivables as factor firm is specialised agency for the same.
The factor carries out assessment of the client with regard to his financial,
operational and managerial capabilities whether his debts are collectable and
viability of his operations. He also assesses the debtor regarding the nature of
business, vulnerability of his operations; and assesses the debtor regarding the
nature of business, vulnerability to seasonality, history of operations, the term of
sales, the track record and bank report available on the past history.

Limitations

The above listed advantages do not mean that the factoring operations are totally
free from any limitation. The attendant risk itself is of very high degree. Some of the
main limitations of such transactions are listed below: 1. It may lead to over-

confidence in the behavior of the client resulting in over-trading or mismanagement.

2 The risk element in factoring gets accentuated due to possible fraudulent acts by
the client in furnishing the main instrument invoice to the factor. Invoicing against
nonexistent goods, pre-invoicing (i.e. invoicing before physical dispatch of goods),
duplicate-invoicing (i.e. making more than one invoice in respect of single
transaction) are some commonly found frauds in such operations, which had put
many factors into difficulty in late 50s all over the world. 3. Lack of professionalism
and competence, underdeveloped expertise, resistance to change etc. are some of
the problems which have made factoring services unpopular. 4. Rights of the factor
resulting from purchase of trade debts are uncertain, not as strong as that in bills of
exchange and are subject to settlement of discounts, returns and allowances. 5.
Small companies with lesser turnover, companies having high concentration on a
few debtors, companies with speculative business, companies selling a large
number of products of various types to general public or companies having large
number of debtors for small amounts etc. may not be suitable for entering into
factoring contracts.

MECHANISM
A factor provides finance to his client upto a certain percentage of
theunpaid invoices which represent the sales of goods or services to
approvedcustomers. The mechanism of the factoring scheme is as
follows:

There should be a factoring arrangement (invoice purchasing

arrangement) between the client(which sells the goods and services to
trade customer incredit) and the factor, which is the financing
organization.

Whenever the client sells goods to the trade customers on credit he

preparesinvoices in the usual way.

The goods are sent to the buyers without raising a bill of exchange
butaccompanied by an invoice.
The debt due by the purchaser to the client is assigned to the factor
byadvising the trade customers to pay the amount due to the client, to
thefactor.

The client hands over the invoices to the factor under cover of a
schedule of offer along with the copies of invoices and receipted
delivery challans.

The factor makes an immediate payment upto 80% of the assigned

invoicesand the balance 20% will be paid on realization of the debt.
TERMS AND CONDITIONS
Assignment of debt in favor of the factor,

Selling limits for the client,

Conditions within which the factor will have recourse to the client in
case of non-payment by the trade customer,

Circumstances under which the factor for his services, say for instance,
as acertain percentage on turnover,
Factor ClientCustomer
Ssale of goodsInvoiceSubmit invoicecopyPayment up to80%
initiallyPays the balance 20% will be paid on realization of the
debt

TERMS AND CONDITIONS

Assignment of debt in favor of the factor,

Selling limits for the client,

Conditions within which the factor will have recourse to the

client in case of non-payment by the trade customer,

Circumstances under which the factor for his services, say for
instance, as acertain percentage on turnover,

Factor ClientCustomer
Pays the amount (In recoursetype customer pays
throughclient)credit sale of goodsInvoiceSubmit
invoicecopyPayment up to80% initiallyPays the balance

Interest to be allowed to the factor on the account where credit

has beensanctioned to the supplier, and

Limit of any overdraft facility and the rate of interest to

be charged byfactor.
FUNCTIONS

Purchase and collection of debt

Sales ledger management

Credit investigation and undertaking of credit risk

Provision of finance against debts

Rendering consulting services

TYPES OF FACTORINGRecourse and Non-recourse
Factoring
Under a recourse factoringarrangement, the factor has recourse
to the client (firm) if the debt purchased/receivablesfactored
turns out to be irrecoverable. If the customer defaults in
payment, the client
hast o m a k e s g o o d t h e l o s s i n c u r r e d b y t h e f a c t o r.

T h e f a c t o r c h a r g e s t h e c l i e n t f o r maintaining the sales

ledger and debt collection services and also for the interest for
the period on the amount drawn by the client.The factor does not
have the right of recourse in the case of non-recourse
factoring.The loss arising out of irrecoverable receivables
is borne by him, as a compensationwhich he charges a
higher commission.
Advance and Maturity Factoring
A drawing limit, as a pre-payment,is made available by the
factor to the client as soon as the factored debts are
approved.The client has to pay interest on the advance
between the date of such payment and thedate of actual
collection from the
customers.T h e m a t u r i n g f a c t o r i n g i s a l s o k n o w n a s
C o l l e c t i o n f a c t o r i n g . U n d e r s u c h arrangements, the
factor does not make a pre-payment to the client. The payment is
madeeither on the guaranteed payment date or on the date of
collection.
FACTORING SERVICES IN INDIA
Though factoring services have been introduced since 1991 in India still it is
quitenew in the sense that factoring product is not widely known in many
parts of the
country. Recognizing the utility of factoring services for small and
medium
sizei n d u s t r i a l a n d c o m me r c i a l e n t e r p r i s e s i n I n d i a , f o r t h e f i r s t t i
m e t h e Vag h u l Committee which submitted its report on the Money
Market, recommended thedevelopment of a system of factoring of open
account sales particularly for thesmall scale industrial units. This committee
further observed that both banks andnon-bank financial institutions in the private
sector should be encouraged to set
upi n s t i t u t i o n s f o r p r o v i d i n g f a c t o r i n g s e r v i c e s . L a t e r , t h e K
a l y a n a s u n d a r a m Committee, which was appointed by the Reserve Bank
of India (RBI) in 1988specifically for exploring the possibilities of launching
factoring services in India,found an abundant scope for such services and

hence strongly advocated for

thei n t r o d u c t i o n o f f a c t o r i n g s e r v i c e s i n I n d i a . T h i s c o m m i t t e e a l s o
o b s e r v e d t h a t banks were ideally suited for providing factoring services
to the industries in theeconomy. However, the said Committeeexpressed the view
that to begin with only four or five banks either individually or j o i n t l y s h o u l d
be allowed on zonal basis to undertake factoring services.
T h e recommendations
of Kalyanasundaram Committee were accepted by the RBI.S u b s e q u e n t l y
a s u i t a b l e a m e n d me n t w a s m a d e i n t h e B a n k i n g R e g u l a t i o n
A c t 1949, so as to allow banks to set up subsidiary company for undertaking
factoringservices. To begin with, the RBI permitted both the State Bank of India
and CanaraBank to start factoring services through their own subsidiaries.
Accordingly, twofactoring companies in India, i.e. SBI Factors and Commercial
Services Ltd. andC a n b a n k F a c t o r s L t d ; s p o n s o r e d b y t h e S t a t e B a n k
o f I n di a a n d C a n a r a B a n k respectively, commenced operations in 1991. In
the beginning they were allowedto operate in Western and Southern Zone of India
respectively. However, later on,the RBI lifted these area restrictions on their
operations and accordingly, both thesecompanies were given permission to
expand and operate their business in other parts of the country. In view of
this, they can operate on all-India basis. In 1993 theRBI
allowed all the scheduled commercial banks to introduce factoring services
either d e p a r t m e n t a l l y o r t h r o u g h a s u b s i d i a r y s e t - u p .
B e s i d e s S B I F a c t o r s a n d C o m m e r c i a l S er v i c e s a n d C a n b a n k F
a c t o r s L t d . , t h e r e a r e a f e w n o n - b a n k i n g finance companies such as
Formost Factors Ltd., Global Trade Finance Pvt. Ltd. (asubsidiary of EXIM
Bank)
and Integrated Financial Services Ltd., which are also inthe business of
domestic factoring in India. Of these, Global Trade Finance Pvt.Ltd. and
Formost Factors Ltd. have undertaken the business of export
factoringalso. Besides these non-banking finance companies, Small Industries
DevelopmentBank of India (SIDBI), Hongkong and Shanghai Banking
Corporation have beenoffering factoring services to their clients. Almost all of
them have been providingfactoring services to the SSI and non-SSI units.

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/1/2/corporate/trade-and-factoring-services
Foremost Factors Limited:
http://www.foremostfactors.net
Global Trade Finance Limited:
http://www.gtfindia.com
Export Credit Guarantee Corporation of India Ltd:
https://www.ecgc.in/Portal/productnservices/maturity/mfactoring.asp
Citibank NA, India:
http://www.citibank.co.in
Small Industries Development Bank of India (SIDBI):
http://www.sidbi.in/fac.asp
Standard Chartered Bank
:www.standardchartered.co.in
CONCLUSION

Factoring is a money market instrument.

Since, factoring is not a negotiable instrument, customers consent isrequired about
the factoring arrangement under which he will make arepayment directly to the
factor but not to the client.

As a result of factoring services, the enterprise can concentrate onmanufacturing

and selling.

The risk of bad debts is eliminated.

The factoring institution also provides advice on business trends and other related
matters.

Domestic Factoring & International Factoring

Factoring is a service that covers the financing and collection of account

receivables in domestic and international trade. It is anongoing arrangement
between the client and Factor, whereinvoices raised on open account sales of goods
and services areregularly assigned to "the Factor" for financing, collection andsales
ledger administration. The buyer and the seller usually havelong term relationships.
The client sells invoiced receivables at adiscount to the factor to raise finance for
working capitalrequirement. The factor may or may not accept the incumbentcredit 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 thecompany may concentrate on production and sales and need
notconcern 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 isimproved. The factor charges service
fees that vary with interestrates in force in the money market.
Domestic Factoring
Through this product, our intention is to be an active partner in themanagement of
your company's supply/delivery chain. Throughdomestic factoring, we could look
at financing your receivablesfrom your buyers. Additionally we also undertake to
finance your vendor/supplier payments.Receivables Finance can be structured
with on a With RecourseBasis (where we would be setting up lines on your
company) or ona Without Recourse Basis.Payments of all your service and utility bills
could be done throughour Vendor Finance product. These could include for
example,courier payments, electricity bills payment.Through this mechanism we
will pay out your service provider onthe due date of the invoice/bill and collect the
money from youafter a pre-determined credit period
International Factoring
In international factoring there are usually two factors. The exportfactor looks at
financing the exporter and sales administration(presenting invoices at the right
time, collecting payments beingthe key tasks). The import factor is interested in
evaluating the buyer, collecting the money on time at the same time ensuring
thathe is protected against default.International factoring encompasses all the four
services, that is, pre-payments, sales ledger administration, credit protection
andcollections.

Guide to International Factoring

:
1.The importer places the order for purchase of goods with theexporter.
2.The exporter requests the Export Factor for limit approval onthe importer. Export
Factor in
3.Turn forwards this request to an Import Factor in theImporter's country. The Import
Factor
4.Evaluates the Importer and conveys its approval to the ExportFactor 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 ImportFactor, who in turn
remits this
11.Payment to the Export Factor.
12.The Export Factor applies the received funds to theoutstanding 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
salestransaction takes place an invoice is prepared in duplicate by the
client,O n e c o p y i s g i v e n t o c u s t o me r a n d s e c o n d c o py i s s e n t t o
t h e f a c t o r.E nt r i e s ar e m a d e i n t h e l e d g e r o n o p e n i t e m m e t h o d .
E a c h r e c i p t i s ma t c h e d a g a i n s t t h e s p e c i f i c i n v o i c e . O n a n y g i v e n
d a t e t h e c u s t o me r account indicate the various open invoices outstanding
.Periodec
reportsa r e s e n t b y f a c t o r t o t h e c l i n t w i t h r e s p e c t t o
c u r r e n t s t a t u s o f t r a n s a c t i o n , t h e p e r i o d i c i t y o f r e p or t i s d e c i

d e d . T h u s t h e e n t i r e s a l e s 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 o f t h e c l i e n t a n d t o r e l i e v e h i m f r o m a l l t h e b o t h e r a t i o
n s p r o b l e m s a s s o c i a t e d w i t h t h e c o l l e c t i o n . Th i s w a y t h e c l i n t
can concentrate on
o t h e r m a j o r ar e a s o f h i s b u s i n e s s o n o n e h a n d a n d r e d u c e t h e c o s t
o f collection by way of saving in labour time and efforts on the other
hand.T h e f a c t o r p o s s e s s e s t r a i n e d a n d e x p e r i e n c e d p e r s o n a l , s o p h i s
t i c a t e d infrastructure and improve technology which helps him to make
timelydemands on the debtors to make payments.
3 . P rov i s i o n of F i n an c e
Finance which is the life blood of a business, is made available easily bythe factor to
the client. A factor purchased the book debts of his client anddebts 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 . P rot e c t i o n Ag a i n s t R i s k
This sevices is provided where the debts are factored without resources.The factor
fixes the credit limit in respect of approved customers. Withinthis limit the
factor undertakes to purchase all trade debts and assumesrisk of default
in payment by the customers. The factor not only relives t h e c l i e n t f r o m
t h e c o l l e c t i o n w or k b u t a l s o a d v i s e s t h e c l i e n t o n t h e creditworthiness
of potential customers . Thus the factor helps the
clienti n a d o p t i n g b e t t e r c r e d i t c o n t r o l p o l i c y . T h e c r e d i t s t a n
ding of the
customers is assessed by the factors on the basis of information
collectedf r o m c r e d i t r a t i n g r e p o r t s , b a n k r e p o r t s , t r a d e r e f e r e n
c e , f i n a n c i a l 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
aclient. Since the factor have better knowledge and wide experience
inf i e l d o f f i n a n c e , a n d p o s s e s s e x t e n s i v e c r e d i t i n f o r m
a t i o n a b o u t customers standing they provide various advisory services on the
mattersrelating to:I.Customers preferences regarding the clients
products.II.Changes in marketing polices of the
competitors.I I I . S u g g e s t i m p r o v e me n t s i n t h e p r o c e d u r e s a d o p t e d
f o r i n v o i c i n g , delivery and sales

return.I V.H e l p i n g t h e c l i e n t s f o r r a i s i n g f i n a n c e f r o m b a n k s / f
i n a n c i a l institutions, etc

SBI Factors and Commercial Services Pvt Ltd (SBIFACTORS)

SBI Factors, a subsidiary of State bank of India (SBI) is one of thel e a d i n g
f a c t o r i n g c o mp a n i e s i n I n d i a w i t h a n a s s e t b a s e o f R s . 7 0 0 . 1 0
crores as on 30.09.2005. It was established in
F e b r u a r y 1 9 9 1 w i t h t h e pr i m a r y o b j e c t i v e t o pr o v i d e d o m e s t i c f a c t
o r i n g services to Small and Medium Enterprises (SMEs). Factoring is
aCollection and finance service designed to improve the cash
flow position of SMEs by turning their credit invoices into ready
cash.T h e m a j o r s t r e n g t h o f t h e c o mp a ny i s t h a t i t h a s p u t i n p l a c e
a t e c h n o l o g y dr i v e n p l a t f o r m f o r o ffe r i n g i n t e g r a t e d r e c e i v a b l e s ma
nagement. SBI and its Associates Banks hold 70% stake in
SBIFactors.S B I F o f f e r s D o m e s t i c F a c t o r i n g W i t h R e c o u r s e a n d
WithoutRecourse. Purchase Bill Factoring, Factoring of Usa
n c e B i l l s Under LC, Channel Financing of Dealers / Distributors and
ExportFactoring Facilities. All its products have been well received by
itsclients.SBIF has ten branches all over the country and it has plans to openthree
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 hasrecorded a NIL NPA position
as at 31.03.2005. It has declared ad i v i d e n d o f 8 % d u r i n g t h e y e a r
2 0 0 5 . I t h a s a m a r k e t s h a r e o f 40.30% as on 30.09.2005.