Factoring (Finance)

Factoring (Finance)

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  FACTORING MEANING HOW DOES ITWORK? BENEFITS FEATURES MECHANICS VARIOUS TYPES FACTORING VS FORFAITING
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  MEANING  Factoring isa financial transaction in which a business sells its accounts receivable to a third party at a discount. It is mainly done to meet it's present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfeiter.
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  How Does FactoringWork?  Factoring is a transaction in which a business sells its invoices, or receivables, to a third-party financial company known as a “factor.” The factor then collects payment on those invoices from the business’s customers. Factoring is known in some industries as “accounts receivable financing.”  The main reason that companies choose to factor is that they want to receive cash quickly on their receivables, rather than waiting the 30 to 60 days it often takes a customer to pay. Factoring allows companies to quickly build up their cash flow, which makes it easier for them to pay employees, handle customer orders and add more business.
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  PROCESS OF FACTORING
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  What Are SomeOther Benefits of Factoring? Boosting cash flow is the main reason most companies factor. However, factoring provides many other advantages as well. Here are a few of them:  Factors provide free back-office support, including managing collections from your customers. This gives you more time and resources to focus on growing your company.  Factoring is based on the quality of your customers’ credit, not your own credit or business history.  Factoring can be customized and managed so that it provides necessary capital when your company needs it.  Factoring is not a loan, so you do not incur debt when you factor.  Factoring is scalable, meaning the amount of funding can grow as your receivables grow.
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  Features of Factoring CreditCover: The factor takes over the risk burden of the client and thereby the client’s credit is covered through advances. Case advances: The factor makes cash advances to the client within 24 hours of receiving the documents.
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  Sales ledgering: As manydocuments are exchanged, all details pertaining to the transaction automatically computerized and stored. Collection Service: The factor, become the clients debts collection of cheques and other follow- procedures are done by the factor in its own interest. Provide Valuable advice: The factors also provide valuable advice on country-wise and customer-wise risks. This is because the factor is in a position to know the companies of its country better than the exporter clients
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  MECHANICS OF FACTORING The client 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)  The client submits invoice copy only with delivery challan showing receipt of goods By buyer, to the factor  The factor, after scrutiny of these papers allows payment (usually up to 80% of the invoice value.) The balance is written as retention money (margin money) this is also called factor reserve
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  TYPES OF FACTORING DOMESTICFACTORING INTERNATIONAL FACTORING
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  DOMESTIC FACTORING  Factoringcan be both domestic and for exports. In domestic Factoring, the client sells goods and services to the customer and delivers the invoices, order, etc., to the Factor and informs the customer of the same. In return, the Factor makes a cash advance and forwards a statement to the client. The Factor then sends a copy of all the statements of accounts, remittances, receipts, etc., to the customer. On receiving them the customer sends the payment to the Factor.
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  TYPES OF DOMESTICFACTORING 1. Full Factoring This is also known as "Without Recourse Factoring ". It is the most comprehensive type of facility offering all types of services namely finance sales ledger administration, collection, debt protection and customer information. 2. Recourse Factoring The Factoring provides all types of facilities except debt protection. This type of service is offered in India. As discussed earlier, under Recourse Factoring, the client's liability to Factor is not discharged until the customer pays in full. 3. Maturity Factoring It is also known as "Collection Factoring ". Under this arrangement, except providing finance, all other basic characteristics of Factoring are present. The payment is effected to the client at the end of collection period or the day of collecting accounts whichever is earlier.
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  4. Advance Factoring: Thiscould be with or without recourse. Under this arrangement, the Factor provides advance at an agreed rate of interest to the client on uncollected and non-due receivables. This is only a pre-payment and not an advance. 5. Invoice Discounting: In this arrangement, the only facility provided by the Factor is finance. In this method the client is a reputed company who would like to deal with its customers directly, including collection, and keep this Factoring arrangement confidential. The client collects payments from customer and hands it over to Factor. The risk involved in invoice discounting is much higher than in any other methods. 6. Bulk Factoring: It is a modified version of Involve discounting wherein notification of assignment of debts is given to the customers. However, the client is subject to full recourse and he carries out his own administration and collection. 7. Agency Factoring: Under this arrangement, the facilities of finance and protection against bad debts are provided by the Factor whereas the sales ledger administration and collection of debts are carried out by the client.
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  INTERNATIONAL FACTORING  Factoringserves as export insurance. Factors, usually working for a factoring company, guarantee the import price of goods to the exporter. It is the exporter who hires the factor. The factor is totally responsible for the cash flow from the importer to the exporter. In essence, credit is outsourced to the factor company.
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  TYPES OF INTERNATIONALFACTORING 1. TWO FACTOR SYSTEMS: In this system, the transaction is based on operations of two factoring companies in two different countries involving four parties: i) Exporter ii) Importer iii) Export factor in exporter's country and iv) Importer factor in importer's country. The various stages of two factor system is explained below.
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  TWO FACTOR SYSTEM [1].Importer issues an order to purchase goods from Exporter. [2]. Exporter (using proforma invoice) requests Export-Factor about a limit for an acceptable cost of Importer’s order. [3]. Export-Factor, in his turn, reconciles the said Importer’s order with Import-Factor. [4]. Import-Factor probes Importer’s financial/credit history. [5]. In the case of positive outputs resulted from probing Importer’s financial/credit history, Import-Factor approves the said deal and issues the corresponding approval to Export-Factor. [6]. The factoring agreement between Export-Factor and Exporter comes into effect. [7]. Exporter delivers the said goods to Importer and, along with other necessary documents, issues the invoice in accordance with the international sale contract. [8]. Exporter transfers the deal’s documentation (international sale contract with open account method of payment) to Export-Factor. [9]. Export-Factor transfers the funds stipulated in the said factoring agreement before. [10]. Export-Factor transfers the said deal’s documentation to Importer and Import-Factor. [11]. By maturing (in accordance with the said invoice issued by Exporter) Importer makes the payment in favour of Import-Factor. [12]. Import-Factor, in his turn, transfers the funds stipulated to Export- Factor. [13]. Export-Factor transfers the funds stipulated to Exporter
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  2. DIRECT EXPORTFACTORING: Under this system only one factoring company is involved i.e., export factor, which provides all elements of service of factoring namely finance to exporter, maintenance of sales ledger and collection of debts from the importers, credit protection in case of financial inability on part of any of the importers. The basic advantage of this system is the obvious reduction in pricing structure coupled with uniform and quick service. 3. DIRECT IMPORT FACTORING: Under this system, the seller will choose to work directly with a factor in the importers country. The import factor is responsible for sales ledger, administration, collection of debts and providing bad debt protection under the agreed level of risk coverage. The disadvantage of the system is the lack of proximity between the exporter and the import factor, which may lead to problems at a later stage.
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  FACTORING AND FORFAITING Factoring is a financial affair which involves the sale of firm’s receivables to another firm or party known as a factor at discounted prices.  On the other hand, forfaiting simply means relinquishing the right. In this, the exporter renounces his/her right due at a future date, in exchange for instant cash payment, at an agreed discount, to the forfeiter.
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  Difference Between Factoringand Forfaiting  Factoring refers to a financial arrangement whereby the business sells its trade receivables to the factor (bank) and receives the cash payment. Forfaiting is a form of export financing in which the exporter sells the claim of trade receivables to the forfeiter and gets an immediate cash payment.  Factoring deals in the receivable that falls due within 90 days. On the other hand, Forfaiting deals in the accounts receivables whose maturity ranges from medium to long term.  Factoring involves the sale of receivables on ordinary goods. Conversely, the sale of receivables on capital goods are made in forfaiting.
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   Factoring provides80-90% finance while forfaiting provides 100% financing of the value of export.  Factoring can be recourse or non-recourse. On the other hand, forfaiting is always non-recourse.  Factoring cost is incurred by the seller or client. Forfaiting cost is incurred by the overseas buyer.  Forfaiting involves dealing with negotiable instruments like bills of exchange and promissory note which is not in the case of Factoring.  In factoring, there is no secondary market, whereas in the forfaiting secondary market exists, which increases the liquidity in forfaiting.
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