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AMITY GLOBAL

BUSINESS SCHOOL Chandigarh


INTRODUCTION




Factoring is a financial transaction whereby a
business sells its accounts receivable
(i.e., invoices) to a third party (called a factor) at
a discount in exchange for immediate money
with which to finance continued business.


AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
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-
1)Finance
2)Maintenance of accounts
3)Collection of debts
4)Protection against credit risk
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Factoring Services - Concept
Definition:
Factoring is defined as 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 clients 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.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Factoring functions..
It is purchasing & collection the
clients a/cs receivables (with or
without recourse),
Sales Ledger management
Credit investigation & undertaking of
risks
Provision of finance against debts
Rendering consultancy services
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Factoring Services - Concept
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Client Customer
Factor
Order placed
Deliver of goods
Client submits invoice
Factor-Prepayment
Monthly statements
Customer pays
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh WHY A FIRM USE
FACTORING




Factoring is used by a firm when the available Cash
Balance held by the firm is insufficient to meet
current obligations and accommodate its other cash
needs, such as new orders or contracts.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
SERVICES OFFERED BY A
FACTOR

a) Follow-up and collection of Receivables from
Clients.
b) Purchase of Receivables with or without recourse.
c) Help in getting information and credit line on
customers (credit protection)
d) Sorting out disputes , due to his relationship with
Buyer & Seller.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
PROCESS INVOLVED IN
FACTORING
a) Client concludes a credit sale with a customer.
b) Client sells the customers account to the Factor and
notifies the customer.
c) Factor makes part payment (advance) against account
purchased, after adjusting for commission and interest
on the advance.
d) Factor maintains the customers account and follows up
for payment.
e) Customer remits the amount due to the Factor.
f) Factor makes the final payment to the Client when the
account is collected or on the guaranteed payment date.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh MECHANICS OF FACTORING
a) The Client (Seller) sells goods to the buyer and prepares
invoice with a notation that debt due on account of this
invoice is assigned to and must be paid to the Factor
(Financial Intermediary).

b) The Client (Seller) submits invoice copy only with Delivery
Challan showing receipt of goods by buyer, to the Factor.

c) The Factor, after scrutiny of these papers, allows payment
(,usually up to 80% of invoice value). The balance is
retained as Retention Money (Margin Money). This is also
called Factor Reserve.


AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
a) The drawing limit is adjusted on a continuous basis after
taking into account the collection of Factored Debts.

b) Once the invoice is honored by the buyer on due date, the
Retention Money credited to the Clients Account.

c) Till the payment of bills, the Factor follows up the payment
and sends regular statements to the Client.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
CHARGES FOR FACTORING
SERVICES
a) Factor charges Commission (as a flat percentage of value of
Debts purchased) (0. 5 0% to 1. 5 0%)

b) Commission is collected up-front.

c) For making immediate part payment, interest charged. Interest
is higher than rate of interest charged on Working Capital
Finance by Banks.

d) If interest is charged up-front, it is called discount.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh TYPES OF FACTORING
a) Recourse Factoring.

b) Non-recourse Factoring.

c) Maturity Factoring.

d) Cross-border Factoring.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh RECOURSE FACTORING

a) Up to 75 % to 85 % of the Invoice Receivable is
factored.
b) Interest is charged from the date of advance to the date
of collection.
c) Factor purchases Receivables on the condition that loss
arising on account of non-recovery will be borne by the
Client.
d) Credit Risk is with the Client.
e) Factor does not participate in the credit sanction
process.
f) In India, factoring is done with recourse.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh NON-RECOURSE FACTORING
a) Factor purchases Receivables on the condition that the Factor has
no recourse to the Client, if the debt turns out to be non-
recoverable.

b) Credit risk is with the Factor.

c) Higher commission is charged.

d) Factor participates in credit sanction process and approves credit
limit given by the Client to the Customer.

e) In USA/UK, factoring is commonly done without recourse.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh MATURITY FACTORING
a) Factor does not make any advance payment to the Client.
b) Pays on guaranteed payment date or on collection of
Receivables.
c) Guaranteed payment date is usually fixed taking into
account previous collection experience of the Client.
d) Nominal Commission is charged.
e) No risk to Factor.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
CROSS - BORDER FACTORING
a) It is similar to domestic factoring except that there are
four parties, viz.,
b) a) Exporter,
c) b) Export Factor,
d) c) Import Factor, and
e) d) Importer.

f) It is also called two-factor system of factoring.
g) Exporter (Client) enters into factoring arrangement with
Export Factor in his country and assigns to him export
receivables.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
export Factor enters into arrangement with

Import Factor and has arrangement for credit
evaluation & collection of payment for an agreed fee.
Notation is made on the invoice that importer has to
make payment to the Import Factor.
Import Factor collects payment and remits to Export
Factor who passes on the proceeds to the Exporter after
adjusting his advance, if any.
Where foreign currency is involved, Factor covers
exchange risk also.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Advantages of Factoring

Factoring provides a large and quick boost to
cashflow.
there are many factoring companies, so prices
are usually competitive
it can be a cost-effective way of outsourcing your
sales ledger while freeing up your time to
manage the business
it assists smoother cashflow and financial
planning
some customers may respect factors and pay
more quickly
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
factors may give you useful information about
the credit standing of your customers and they
can help you to negotiate better terms with your
suppliers
factors can prove an excellent strategic - as well
as financial - resource when planning business
growth
you will be protected from bad debts if you
choose non-recourse factoring - see the page in
this guide on recourse factoring and non-
recourse factoring
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
cash is released as soon as orders are invoiced
and is available for capital investment and
funding of your next orders
factors will credit check your customers and can
help your business trade with better quality
customers and improved debtor spread




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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Demerits of Factoring
The cost will mean a reduction in your profit
margin on each order or service fulfilment.
It may reduce the scope for other borrowing -
book debts will not be available as security.
Factors will restrict funding against poor quality
debtors or poor debtor spread, so you will need
to manage these funding fluctuations.
It may be difficult to end an arrangement with a
factor as you will have to pay off any money they
have advanced you on invoices if the customer
has not paid them yet.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Some customers may prefer to deal directly with
you.
How the factor deals with your customers will
affect what your customers think of you. Make
sure you use a reputable company that will not
damage your reputation.
You have to pay extra to remove your liability for
bad debtors.


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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh FACTORING IN INDIA
a) Kalyana Sundaram Committee recommended
introduction of factoring in 1989.
b) Banking Regulation Act, 1949, was amended in 1991 for
Banks setting up factoring services.
c) SBI/ Canara Bank have set up their Factoring
Subsidiaries:-
d) SBI Factors Ltd., (April, 1991) ( an asset base of Rs
1908.00 corers as on March 31, 2008, highest in India)
e) Canara Bank Factors Ltd., (August, 1991).
f) RBI has permitted Banks to undertake factoring services
through subsidiaries.

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Why we need Factoring?
For Smooth cash flow

For meeting working capital needs

Overcome the situation from high cost
of capital and reduced profit
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
What is Forfaiting ?
Forfait is derived from French word a
forfait which means forfeiting or surrender of
rights
It is a mechanism of financing exports
by discounting export receivables
evidenced by Bills of Exchange or Promissory
Notes
without recourse to the seller (viz exporter)
carrying medium to long term maturities
on a fixed rate basis (discount)
upto 100 per cent of the contract value
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Forfaiting..

It is a highly flexible technique that allows an Exporter
to grant attractive credit terms to foreign Buyers,
without tying up cash flow or assuming the risks of
possible late payment or default. Simultaneously, the
Exporter is fully protected against interest and/or
currency rates moving unfavourably during the credit
period

Forfaiting is a highly effective sales tool, which
simultaneously improves cash-flow and eliminates
risk.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Six Parties in Forfaiting
1. Exporter (India)
2. Importer (Abroad)
3. Exporters Bank (India)
4. Importers/Avalising Bank (Abroad)
5. EXIM Bank (India )
6. Forfaiter (Abroad)
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Mechanism
1. The exporter and importer negotiate the
proposed export sale contract. Then the
exporter approaches the forfaiter to ascertain
the terms of forfaiting.
2. The forfaiter collects details about the
importer, supply and credit terms,
documentation etc.
3. Forfaiter ascertains the country risk and credit
risk involved.
.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
4. The forfaiter quotes the discount rate.
5. The exporter then quotes a contract price to the
overseas buyer by loading the discount rate,
commitment fee etc. on the sale price of the
goods to be exported.
6. The exporter and forfaiter sign a contract.
7. Export takes place against documents
guaranteed by the importers bank.
8. The exporter discounts the bill with the forfaiter
and the latter presents the same to the importer
for payment on due date or even sell it in
secondary market.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Costs of forfaiting
The forfaiting transaction has typically three cost
elements:
1. Commitment fee, payable by the exporter to
the forfaiter for latters commitment to execute a
specific forfaiting transaction at a firm discount
rate with in a specified time.
2. Discount fee, interest payable by the exporter
for the entire period of credit involved and
deducted by the forfaiter from the amount paid to
the exporter against the availised promissory
notes or bills of exchange.
3. Documentation fee.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Benefits of forfaiting
1. It frees the exporter from political or
commercial risks from abroad.

2. Forfaiting offers without recourse finance to
an exporter. It does not effect the exporters
borrowing limits/capacity.

3. Forfaiting relieves the exporter from
botheration of credit administration and
collection problems.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
4. Forfeiting is specific to a transaction. It does
not require long term banking relationship with
forfeiter.

5. Exporter saves money on insurance costs
because forfeiting eliminates the need for export
credit insurance.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Benefits to Exporters
Converts a Deferred Payment export into a
cash transaction, improves liquidity
Frees Exporter from cross-border political or
commercial risks associated
Finances upto 100 percent of export value
It is a Without Recourse finance
Hedges against Interest and Exchange Risks

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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
FACTORING vs. FORFAITING
POINTS OF
DIFFERENCE
FACTORING FORFAITING
Extent of Finance Usually 75 80% of the
value of the invoice
100% of Invoice value
Credit
Worthiness
Factor does the credit
rating in case of non-
recourse factoring
transaction
The Forfaiting Bank
relies on the
creditability of the
Avalling Bank.
Services provided Day-to-day administration
of sales and other allied
services
No services are
provided
Recourse With or without recourse Always without
recourse
Sales By Turnover By Bills
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BUSINESS SCHOOL Chandigarh
DIFFERENCE BETWEEN
FACTORING AND FORFAITING
1.Suitable for ongoing open
account sales, not backed
by LC or accepted bills or
exchange.
2. Usually provides financing
for short-term credit period
of upto 180 days.
1. Oriented towards single
transactions backed by LC
or bank guarantee.
2. Financing is usually for
medium to long-term credit
periods from 180 days upto
7 years though shorterm
credit of 30180 days is
also available for large
transactions.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
DIFFERENCE BETWEEN
FACTORING AND FORFAITING
3.Requires a continuous
arrangements between
factor and client, whereby
all sales are routed through
the factor.
4. Factor assumes
responsibility for collection,
helps client to reduce his
own overheads.
3. Seller need not route or
commit other business to
the forfaiter. Deals are
concluded transaction-wise.

4. Forfaiters responsibility
extends to collection of
forfeited debt only. Existing
financing lines remains
unaffected.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
DIFFERENCE BETWEEN
FACTORING AND FORFAITING
5. Separate charges are
applied for
financing
collection
administration
credit protection and
provision of information.
5. Single discount charges is
applied which depend on
guaranteeing bank and
country risk,
credit period involved
and
currency of debt.
Only additional charges is
commitment fee, if firm
commitment is required
prior to draw down during
delivery period.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
DIFFERENCE BETWEEN
FACTORING AND FORFAITING
6. Service is available for
domestic and export
receivables.
7. Financing can be with
or without recourse; the
credit protection
collection and
administration services
may also be provided
without financing.
6. Usually available for
export receivables only
denominated in any
freely convertible
currency.
7. It is always without
recourse and
essentially a financing
product.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
List of some Forfaiters
Standard Bank, London
Hong Kong Bank
Indo Aval
ABN AMRO Bank
Meghraj Financial Services
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