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Factoring
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- 2. WHAT IS FACTORING? Factoringis 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
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- 4. a) Client concludesa credit sale with a customer. b) Client sells the customer’s 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 customer’s 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. PROCESS INVOLVED IN FACTORING
- 5. DIFFERENCE BETWEEN FACTORINGAND A BANK LOAN •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.
- 7. FACTORING CONCEPT • Infactoring, a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80%(rarely up to 90%) of the amount immediately on agreement. • Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when the customer pays the debt. • Collection of debt from the customer is done either by the factor or the client depending upon the type of factoring.
- 8. TYPES OF FACTORING D O M E S T I C FA C TO R I N G I N T E R N AT I O N A L FA C TO R I N G R E C O U R S E FA C TO R I N G N O N R E C O U R S E FA C TO R I N G M AT U R I T Y FA C TO R I N G I N VO I C E FA C TO R I N G
- 9. Domestic Factoring The factoringarrangement where all the three- the factor, the seller and the buyer are in the same country, subject to the same laws. International Factoring The factoring arrangement, where the seller and the buyer are in two different countries involving co-operation between two factoring companies, one in the seller’s country (Export Factor) and the other in the buyer’s country (Import Factor). Generally it is based on non recourse factoring Invoice Discounting In this type of factoring arrangement, only finance is provided and no other service is offered.
- 10. Recourse Factoring In thistype of factoring arrangement, the factor provides all types of facilities except debt protection. In other words, the client is responsible for any bad debts incurred 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. Credit Risk is with the Client. Factor does not participate in the credit sanction process. In India, factoring is done with recourse.
- 11. Non-Recourse Factoring It givesprotection against bad debts to the client. In other words, in case the customer fails to pay, the factor will have ‘no recourse’ to the client and will have to absorb the bad debts himself. 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.
- 12. Maturity factor Factor doesnot 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. Disclose factoring The debtor is informed of the assignment of debts and debtor directly pays the money to the factor Undisclosed factoring The debtor is not informed of the agreement entered into between the seller and the factor. Most of the cases disclose factoring is happen in UK
- 13. FACTORING CHARGES Finance Charge- It represents the interest on funds made available to the client by way of prepayment against purchase of approved invoices. Service Charge - The charge levied for rendering non- funding services such as collection, sales ledger maintenance and other advisory services. One time setup fee
- 14. WHY USE FACTORING? •Through the use of Factoring receivables are instantly converted into cash leading to improved cash flows that can help funding of future growth. • It facilitate an efficient follow up of payments from buyers, which is made possible through relationships developed by factors with client’s buyers. • Factoring provides credit protection for export sales which enables to do business with buyers who are unwilling to open Letters of Credit. • Factoring also provides other peripheral services such as advisory services, credit assessment, etc. • 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
- 15. FACTORING IS NOTSUITABLE UNDER FOLLOWING CASES a) where large volume of cash sales take place. b) engaged in speculative business. c) selling highly specialized capital equipment's or made-to-order goods. d) where credit period offered to the buyers is more than 180 days. e) where sales are to the sister / associated companies f) where sales are to the public at large, etc.
- 16. BENEFITS OF FACTORING •Theclient will be relieved of the work relating to sales ledger administration and debt collection •The client can therefore concentrate more on planning production and sales. •The charges paid to a factor which will be marginally high at 1 to 1.5% than the bank charges will be more than compensated by reductions in administrative expenditure. •This will also improve the current ratio of the client and consequently his credit rating.
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- 18. ABC Aviation Inc.,a fictional reseller of aviation parts, has focused on international sales and was recently awarded contracts by companies in Guatemala and Peru. Two of these contracts were small, totalling $250,000 in sales, and were due in one month. The third contract, however, was valued at $500,000 – a substantial amount for ABC Aviation. The parts for this contract were due in two months. The following table outlines the orders: Contract COGS Sale revenue Delivery Date Terms 1 $55,000 $100,000 Next month Net 45 2 $82,500 $1,50,000 Next month Net 45 3 $3,00,000 $5,00,000 2 months Net 45 The company has $150,000 in the bank – enough to cover the Cost of Goods Sold (COGS) for the first two contracts, but not enough to cover the third contract. The only way that ABC Aviation can fulfil these contracts is to use financing.
- 19. Working with theExport Import Bank: Ex-Im Bank’s export credit insurance was critical for the success of the transaction. The company managed to get the foreign clients approved, which covered up to 80% of the receivable face value in case of default. This coverage limited the risk to the point that the transaction could be financed using factoring.
- 20. Step 1: Delivercontracts 1 & 2 Before export factoring- Contracts Cash Bank A/R Payroll General Expenses 2 $1,50,000 $2,50,000 $10,000 $1,37,000 Cash surplus $2500 Step 2: Use export factoring on first two invoices After export factoring- Contracts Cash (bank) A/R Reserve Payroll General Expenses 2 $3,50,000 $0 $50,000 $10,000 $1,37,500 Cash surplus $2,02,500
- 21. Step 3: Deploypurchase order finance Immediately after PO fund Contract Cash (bank) A/R Reserve Payroll General expense All 3 $3,50,000 $5,00,000 $50,000 $10,000 $4,37,500 Cash surplus $3,02,500 Step 4: Factor the invoice for the last contract After Export Factoring Contracts Cash (bank) A/R Reserve Payroll General expenses All 3 $7,50,000 $0 $1,50,000 $10,000 $4,37,500 Cash surplus $3,02,500
- 22. What if aforeign client does not pay? Account debtor default is an inherent risk in international transactions, where collections can be difficult. However, this risk was greatly minimized by using the Export-Import Bank’s credit insurance program.
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