Unit 5 Factoring and Forfaiting - FIS

Factoring and Forfaiting

1. UNIT-5 FACTORING & FORFAITING Mr. VIPULKUMAR N M ASSISTANT PROFESSOR DEPARTMENT OF COMMERCE KRISTU JAYANTI COLLEGE (AUTONOMOUS) BENGALURU

2. 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. Factoring is a financial transaction/relationship, where by a business sells its A ccounts R eceivable (invoices) (Sundry Debtors+ Bills Receivables) to a third party (called a factor) at a discount. Thus it is a financing method in which a business owner sells Accounts Receivable at a discount to a third party funding source to raise capital ( Working Capital). Meaning

3. Parties to the factoring The buyer of the goods The seller of the goods The factor ( F inancial Institution) The 3 parties interact with each other during the purchase and Sale of goods.

4. How Does Factoring Works….

5. MECHANISM OF FACTORING An agreement is entered into between the selling firm and the factor firm. The agreement provides the basis and scope of the understanding reached between the two for rendering factor services The sale documents should contain the instructions to make payments directly to the factor who is assigned the job of collection of receivables.

6. When the payment is received by the factor , the account of the selling firm is credited by the factor after deducting its fees, charges, interest etc as agreed. The factor may provide advance finance to the selling firm if the conditions of the agreement so require.

7. TYPES OF FACTORING

8. 1. Recourse F actoring - In this, the client (seller firm) is liable for any bad debts inured. 2. Non R ecourse F actoring- In this, the factor assumes the entire credit risk. Full amount of invoice is paid to the client ( Seller Firm) in the event of the debt becoming bad. Since the factor bears the risk of non payment, commission or fees charge for the services in case of non recourse factoring is higher than under the course factoring.

9. 3. Advance Factoring – In this, the factor provides an immediate advance (75-90%) of the approved receivables to the client (Seller Firm). 4. Maturity F actoring – In this no advance is paid to the 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.

10. 5. Conventional or Full Factoring - Under this 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 maturity wise and takes up the risk of default and will have claims on the debtor as also the client creditor. 6. Disclosed and Undisclosed F actoring – In disclose 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. Under undisclosed factoring , the name of the factor is not disclosed in the invoice, but still the control lies with the factor.

11. 7. International F actoring – It refers to the factoring of export sales. An international factoring house, in addition to the usual service of a factor also undertakes the responsibility of completing of all legal and procedural formalities concerned with export sales, hence client is saved from the trouble of getting itself involved in the complexities associated with international trade.

12. Functions of Factoring Administration of sellers sales ledger Collection of Receivables Provision of Finance Protection against risk Advisory services Maintains cash flow management

13. 1 . Administration of sales ledger The factor maintains sales ledger in respect of each client. When the sales transactions take place, an invoice is prepared in duplicate by the client, one copy is given to the customer and second copy is sent to the factor. 2. Collection of receivables The main function of the factor is to collect the receivables on behalf of the client and to relieve him from all the botheration's associated with the collection. So the client can concentrate on major areas of his business on one hand and reduce the cost of collection by way of savings in labour, time and efforts on the other hand.

14. 3. Provision of Finance Finance is made available easily by the factor to the client. A factor purchases the book debt of his client and debts are assigned in favour of the client. 75 to 80% of the assigned debts is given as an advance to the client by the factor. 4.Protection against Risk This service is provided where the debts are factored without recourse. The factor fixes the credit limit in respect of approved customers and assumes the risk of default in payment by the customers.

15. 5. Advisory Services These services arise out of the close relationship between a factor and a client. Since the factor have better knowledge and wide experience in the field of finance, and possess extensive credit information about the customers standing, they provide various advisory services as and when required to the clients. 6. Maintains the cash flow management. By providing advance payment against receivables, the factors helps the clients to maintain a steady cash flow in the organization.

16. FORFAITING

17. Meaning Forfaiting refers to the financing of receivables pertaining to international trade. Forfaiting is a mechanism by which the right for export receivables of an exporter(client) is purchased by a financial intermediary (forfeiter)without recourse to him.

18. Forfaiting is also defined as the trade finance extended by a forfaiter to an exporter/seller for an export/sale transaction involving deferred payments terms over a long period at a firm rate of discount. Its generally extended for capital goods , commodities and services where the importer insists on supplies on credit terms. It case of forfaiting medium term or long term receivables are involved.

19. Thus forfaiting is a mechanism of financing exports: By discounting export receivables Evidenced by bills of exchanges or promissory notes Without recourse to the seller Carrying medium to log term maturities On a fixed rate basis up to 100% of contract value

20. PARTIES TO FORFAITING There are 5 parties involved in forfaiting a) Exporter b) Importer c) Exporter’s bank d) Importer’s bank e) The forfaiter

21. Advantages of Forfaiting It frees the exporter from political or commercial risks from abroad Forfaiting offers ‘without recourse’ finance to an exporter. It does not effect the exporter’s borrowing limits/capacity Forfaiting relieves the exporter from botheration of credit administration and collection problems. Forfaiting is specific to a transaction. It does not require long term banking relationship with forfaiter . Exporter saves money on insurance costs because it eliminates the need for export credit insurance

22. What Information Does a Forfaiter Need? The forfaiter requires the following information to participate in the transaction : The identity of the buyer Buyer’s nationality Nature of goods sold Detail of the value Currency of contract Date and duration of the contract Credit terms Payment schedule Interest rate Know what evidence of debt will be used, e.g., promissory notes, bills of exchange, letter of credit, etc. The identity of the guarantor of payment

23. Documents Required by the Forfaiter from the Exporter Copy of supply contract, or its payment’s terms Copy of shipping documents, including airway bill, bill of lading, certificates of receipt, railway bill, or equivalent documents Copy of signed commercial invoice Letter of assignment and notification to the guarantor Letter of guarantee

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