Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing.
There are three parties directly involved: the factor who purchases the receivable, the one who sells the receivable, and the debtor who has a financial liability that requires him or her to make a payment to the owner of the invoice.
There are various types of factoring:
Recourse, Non - recourse, maturity and cross - border factoring.
2. FACTORING
The word “Factor” has been derived from the
Latin word “Facere” which means “to make or to
do or to get things done”. 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 latter purchases the receivables of
the former and also controls and administers
the receivables of the former.
3. Who is a factor?
A factor is a financial institution that
specializes in purchasing receivables from
business firms. Factor assumes the risk of
collection of receivables and on the event of
non payment by debtors/customers bears the
risk of bad debt and losses.
4. PARTIES INVOLVED IN
FACTORING
The parties involved in the factoring
transaction are:-
a) Supplier or Seller (Client)
b) Buyer or Debtor (Customer)
c) Financial Intermediary (Factor)
5. CHARACTERISTICS OF
FACTORING
Usually the period for factoring is 90 to 150
days. Some factoring companies allow even
more than 150 days.
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).
6. Factoring is considered to be a costly
source of finance compared to other sources
of short term borrowings.
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.
7. Follow-up and collection of Receivables
from Clients.
Purchase of Receivables with or without
recourse.
Help in getting information and credit line
on customers (credit protection)
Sorting out disputes, if any, due to his
relationship with Buyer & Seller.
SERVICES OFFERED BY
FACTORING
9. PROCESS INVOLVED IN FACTORING
Client concludes a credit sale with a customer.
Client sells the customer’s account to the Factor
and notifies the customer.
Factor makes part payment (advance) against
account purchased, after adjusting for commission
and interest on the advance.
Factor maintains the customer’s account and
follows up for payment.
Customer remits the amount due to the Factor.
Factor makes the final payment to the Client when
the account is collected or on the guaranteed
payment date.
10. MECHANISM OF FACTORING
a) 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.
b) The sales documents should contain the
instructions to make payment directly to the
factor who is assigned the job of collection of
receivables.
11. c) 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.
d) The factor may provide advance finance to
the selling firm conditions of the agreement
so require.
13. RECOURSE FACTORING
Upto 75% to 85% of the Invoice Receivable is
factored.
Interest is charged from the date of advance to
the date of collection.
Factor purchases Receivables on the condition
that loss arising on account of non-recovery
will be borne by the Client (seller firm).
Credit Risk is with the Client.
Factor does not participate in the credit
sanction process.
In India, factoring is done with recourse.
14. NON-RECOURSE FACTORING
Factor purchases Receivables on the
condition that the Factor has no recourse to
the Client, if the debt turns out to be non-
recoverable.
Credit risk is with the Factor.
Higher commission is charged.
Factor participates in credit sanction process
and approves credit limit given by the Client
to the Customer.
In USA/UK, factoring is commonly done
without recourse.
15. MATURITY FACTORING
Factor does not make any advance payment
to the Client.
Pays on guaranteed payment date or on
collection of Receivables.
Guaranteed payment date is usually fixed
taking into account previous collection
experience of the Client.
Nominal Commission is charged.
No risk to Factor.
16. CROSS - BORDER FACTORING
It is similar to domestic factoring except that
there are four parties:
a) Exporter
b) Export Factor
c) Import Factor
d) Importer
It is also called two-factor system of factoring.
17. Exporter (Client) enters into factoring
arrangement with Export Factor in his country
and assigns to him export receivables.
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.
18. FACTORING COMPANIES IN
INDIA
Canbank Factors Limited
SBI Factors and Commercial Services Pvt.
Ltd.
The Hongkong and Shanghai Banking
Corporation Ltd.
Foremost Factors Limited
Global Trade Finance Limited
Export Credit Guarantee Corporation of
India Ltd.
Small Industries Development Bank of India
(SIDBI)
19. STATUTES APPLICABLE TO
FACTORING
Factoring transactions in India are governed by
the following Acts:-
Indian Contract Act
Sale of Goods Act
Transfer of Property Act
Banking Regulation Act.
Foreign Exchange Regulation Act.
