Factoring

One of the oldest forms of business financing, factoring is the cash-management tool of choice for many companies. Factoring is very common in certain industries, such as the clothing industry, where long receivables are part of the business cycle.

1. FACTORING

2. DEFINITION 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.

3. Factoring vs Bank Loan Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

4. Functions of Factoring Credit Evaluation : Assessment of credit-worthiness of customer Sales Ledger Administration : Recording, analysing, and reporting sales transactions Collect Book Debts : Collection of accounts receivables from customers as & when they become due Assume Risk of Default : Collection of receivables from customers, relieving the client-firm of credit risk or bad debt losses.

5. FUNCTIONS OF THE FACTORING Provide Finance : Providing finance to client-firm against book debts, upto 90% of invoice value of the factored receivables Provide Information : Advisory services on marketing strategies and foreign collaborations, sales analysis, invoice analysis, etc Provide Insurance : Debt Insurance to client-firm against possible losses due to bankruptcy or insolvency

6. ADVANTAGES 1. It helps to improve the current ratio. Improvement in the current ratio is an indication of improved liquidity. Enables better working capital management. 2 . It increases the turnover of stocks. 3 . It ensures prompt payment and reduction in debt. 4 . It helps to reduce the risk. Present risk in bills financing like finance against accommodation bills can be reduced to minimum. 5. It helps to avoid collection department. The client need not undertake any responsibility of collecting the dues from the buyers of the goods.

7. Limitations 1. Factoring is a high risk area, and it may result in over dependence on factoring, mismanagement, over trading of even dishonesty on behalf of the clients. 2. It is uneconomical for small companies with less turnover. 3. The factoring is not suitable to the company’s manufacturing and selling highly specialized items because the factor may not have sufficient expertise to assess the credit risk. 4. The developing countries such as India are not able to be well verse in factoring. The reason is lack of professionalism, non-acceptance of change and developed expertise .

8. Process of Factoring

9. TYPES OF FACTORING Recourse factoring Non-recourse factoring Advance factoring Maturity factoring Invoice factoring Supplier guarantee factoring Bank participation factoring Cross-border factoring Confidential & undisclosed factoring

10. Recourse & Non-Recourse Factoring Recourse Factoring: In Recourse factoring, the credit risk remains with the client though the debt is assigned to the factor, i.e., the factor can have recourse to the client in the event of non-payment by the customer. Non-Recourse Factoring: The Non-Recourse Factoring, also called as ‘Old-line factoring’, is an arrangement whereby he factor has no recourse to the client when the bill remains unpaid by the customer. Thus, the risk of bad debt is absorbed by the factor.

11. Maturity & Advance Factoring Maturity Factoring: In maturity factoring method, the factor may agree to pay an amount to the client for the bills purchased by him either immediately or on maturity. The later refers to a date agreed upon on which the factor pays the client. Advance Factoring: Where the payment is made by the factor immediately is called Advance Factoring Under this type of factoring, the factor provides financial accommodation apart from non-financial services rendered by him.

12. INVOICE FACTORING It is simply a bill discounting process. Invoice discounting is a form of short-term borrowing often used to improve a company's working capital and cash flow position. Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid. To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the borrowing.

13. Confidential and Undisclosed Factoring In confidential and undisclosed factoring the arrangement between the factor and the client are left un-notified to the customers and the client collects the bills from the customers without intimating them to the factoring arrangements.

14. Supplier Guarantee Factoring Supplier Guarantee Factoring is also known as ‘drop shipment factoring’. This happens when the client is a mediator between supplier and customer. When the client is a distributor, the factor guarantees the supplier against the invoices raised by the supplier upon the client and the goods may be delivered to the customer. The client thereafter raises bills on the customer and assigns them to the factor. The factor thus enables the client to make a gross profit with no financial involvement at all.

15. Bank Participation & Cross-border/International Factoring Bank Participation Factoring: In bank participation factoring the bank takes a floating charge on the client’s equity i.e., the amount payable by the factor to the client in .respect of his receivables. On this basis, the bank lends to the client and enables him to have double financing. Cross-border/International Factoring: In domestic factoring, there are 3 parties involved – customer, client and factor. But in international factoring, 4 parties are involved, namely – exporter(client), importer(customer), export factor, and import factor.

16. Financial Aspects

17. FACTORING & BALANCE SHEET

18. Factoring & Balance Sheet Impact of Factoring on Balance Sheet: Reduction of Current Liabilities. Improvement in Current Ratio and Efficiency. Higher credit standing. Reduction of cost and expenses.

19. Factoring and P&L Account The Benefits of factoring in terms of the profit and loss account are analyzed as under: The factor performs basis functions like administration of seller’s sales ledger, credit control, collection of dues, etc. This saves the administration costs . The improved liquidity position enables the firm to honour its obligations without any 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 purchases, cash discount on early payment, better market standing, quicker sanction of loans and advances, and better terms and conditions while borrowing etc.

20. Factoring Charges Finance Charge : Finance charge is computed on the prepayment outstanding in the client’s account at monthly intervals. Finance charges are only for financing that has been availed. These charges are similar to the interest levied on the cash credit facilities in a bank . Service fee : Service charge is a nominal charge levied at monthly intervals to cover the cost of services, namely, collection, sales ledger management, and periodical MIS reports. Service fee is determined on the basis of criteria such as the gross sales value, number of customers, the number of invoices and credit notes, and the degree of credit risk represented by the customers or the transaction.

21. Prospects of Factoring in India

22. The Kalyanasundaram report In 1988, RBI formed a committee headed by CS Kalyansundaram , a former managing director of the State Bank of India SBI to examine the need for and the scope of factoring organizations in India. The committee submitted its report in December 1988 and recommended introduction of factoring services in India. The RBI advised banks to take up factoring activity through a subsidiary.

23. Need for Factoring Services in India There is sufficient scope for the introduction of factoring services in India, which would be complementary to the services provided by banks. The introduction of export factoring services in India would provide an additional facility to exporters. With a view to attaining a balanced dispersal of risks, factors should offer their services to all industries and all sectors of the economy.

24. RBI Guidelines Banks are permitted to set up separate subsidiaries/invest in factoring companies. Should not engage in financing of other companies or other factoring companies. Investment of a bank cannot exceed in the aggregate 10% of paid-up capital and reserves of the bank. According to the RBI guidelines (2010), banks now with the prior approval of RBI can form subsidiary companies for undertaking the factoring services and other incidental activities.

25. SBI Factors and Commercial Services The State Bank of India, in association with the State Bank of Indore, the State Bank of Saurashtra, SIDBI, and the Union Bank of India set up the SBI Factors and Commercial Services in February 1991. SBI Factors commenced operations from April 1991. SBI factors was the first factoring company to be set up in India. It has a 45% market share in this business. SBI Factors offers domestic, export, and import factoring services .

26. SBI Factors and Commercial Services SBI factors offers two types of products under domestic factoring: Bill2Cash : - The seller invoices the goods to the buyer, assigns the same to SBI factors, and receives prepayment up to 90 percent of the invoice values immediately. Cash4Purchase : Facilitates instant payment for purchases made and is generally sanctioned in conjunction with receivable factoring facility or export factoring.

27. Canbank Factors Ltd. Jointly promoted by the Canara Bank, Andhra Bank and SIDBI in August,1992. Its Rs. 10 crore paid-up capital was contributed in the proportion of 60:20:20 by three promoters respectively. Initially operated in the south zone but regional restrictions on their operations were subsequently removed by the RBI. Main services provided by the Canbank Factors Ltd are domestic factoring and invoice discounting.

28. Reasons for Slow Growth The overall worldwide growth in factoring is estimated at 12%. Europe has the largest market representing 64% of the world volumes with a growth of 18% during the year. America's growth was 10%, whereas Australia recorded impressive growth of 40%. Asia saw a fall in volume. The growth trends mentioned above support the fact that there is enormous scope for expansion worldwide and India is no exception to this. The potential in India is estimated at an annual turnover of Rs . 15000 to Rs . 20000 crore , but large portion is untapped.

29. Reasons for Slow Growth Lack of a credit appraisal system and authentic information about customers and clients restricts the growth of this business. Higher stamp duty on assigning of debt increases the cost of the client which reduces factoring arrangements. Non availability of permission to factoring companies for raising their debt restricts their financing capacity and thereby growth of the market. Being registered as NBFCs, factoring companies are not eligible for refinance which limits the extension of this facility to the exporters on open account sales. This restricts the growth of the market .

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