TERM PAPER

MANAEGEMENT OF
FINANCIAL SERVICES

FACTORING

SUBMITTED TO:- SUBMITTED By:-

MR. Sanjay Medhavi Alok Arya

M B A – 3rd Sem
What is factoring?

Factoring is a financial option for the management of

receivables.

In simple definition it is the conversion of credit sales into cash.

In

factoring, 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. We will see

different types of factoring in this article. The account

receivable

in factoring can either be for a product or service. Examples are

factoring against goods purchased, factoring for construction

services (usually for government contracts where the

government

body is capable of paying back the debt in the stipulated period

of
factoring. Contractors submit invoices to get cash instantly),

factoring against medical insurance etc. Let us see how factoring

is

done against an invoice of goods purchased.

Flow Chart of Factoring

credit sale of
goods
Customer Client
Invoic
e

Pays the
balance
Pays the amount (In recourse amount
type customer pays through Submit invoice
client) copy

Payment up to
80% initially

Factor
Characteristics of factoring

1. Usually the period for factoring is 90 to 150 days. Some

factoring companies allow even more than 150 days.

2. Factoring is considered to be a costly source of finance

compared to other sources of short term borrowings.

3. 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). Hence these companies can

leverage on the financial strength of their customers.

4. 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.

5. Factoring is a method of off balance sheet financing.

Cost of factoring=finance cost + operating cost. Factoring

cost vary according to the transaction size, financial

strength

of the customer etc. The cost of factoring vary from 1.5%

to

3% per month depending upon the financial strength of the

client's customer.

6. Indian firms offer factoring for invoices as low as 1000Rs

For delayed payments beyond the approved credit period,

penal charge of around 1-2% per month over and above

the

normal cost is charged (it varies like 1% for the first month

and 2% afterwards).
Different types of Factoring

1. Disclosed and Undisclosed

2. Recourse and Non recourse

A single factoring company may not offer all these services

Disclosed
In disclosed factoring client's customers are notified of the

factoring agreement. Disclosed type can either be recourse or

non

recourse.

Undisclosed
In undisclosed factoring, client's customers are not notified of
the
factoring arrangement. Sales ledger administration and
collection

of debts are undertaken by the client himself. Client has to pay

the

amount to the factor irrespective of whether customer has paid

or

not. But in disclosed type factor may or may not be responsible

for

the collection of debts depending on whether it is recourse or

non

recourse.

Recourse factoring
In recourse factoring, client undertakes to collect the debts from

the customer. If the customer don't pay the amount on maturity,

factor will recover the amount from the client. This is the most

common type of factoring. Recourse factoring is offered at a

lower

interest rate since the risk by the factor is low. Balance amount
is

paid to client when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts

from the customer. Balance amount is paid to client at the end of

the credit period or when the customer pays the factor

whichever

comes first. The advantage of non recourse factoring is that

continuous factoring will eliminate the need for credit and

collection departments in the organization.

Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com

SBI Factors and Commercial Services Pvt. Ltd:

http://www.sbifactors.com

The Hongkong and Shanghai Banking Corporation Ltd:

http://www.hsbc.co.in/in/corp/factserv.htm

Foremost Factors Limited: http://www.foremostfactors.net

Global Trade Finance Limited: http://www.gtfindia.com

Export Credit Guarantee Corporation of India Ltd:

http://www.ecgcindia.com

Citibank NA, India: http://www.citibank.co.in

Small Industries Development Bank of India (SIDBI):

http://www.sidbi.in/fac.asp
Domestic Factoring & International Factoring

Factoring is a service that covers the financing and collection of

account receivables in domestic and international trade. It is an

ongoing arrangement between the client and Factor, where

invoices raised on open account sales of goods and services are

regularly assigned to "the Factor" for financing, collection and

sales ledger administration. The buyer and the seller usually

have

long term relationships. The client sells invoiced receivables at a

discount to the factor to raise finance for working capital

requirement. The factor may or may not accept the incumbent

credit risk. Factoring enables companies to sell their outstanding

book debts for cash.

The factor operates by buying from the selling company their

invoiced debts. These are purchased, usually with credit

protection,

by the factor who then will be responsible for all credit control,

collection and sales accounting work. Thus the management of

the
company may concentrate on production and sales and need not

concern itself with non-profitable control and sales accounting

matters.

By obtaining payment of the invoices immediately from the

factor, usually up to 80% of their value the company's cash flow
is improved. The factor charges service fees that vary with
interest rates in force in the money market.
 The world's local bank

Trade & Factoring Services

HSBC currently offers both domestic and international factoring

products.

HSBC provides finance solutions for all your sales and purchase
requirements on the domestic front, and various export-factoring
product services on the international level.

Our factoring services offer a comprehensive receivables and

payables management solution which includes transaction
financing, credit protection, sales ledger administration and
payment collection.
At HSBC, our ability to be the comprehensive provider of Trade
Solutions makes us a leading player in the Trade & Factoring
market in India.
We have dedicated Relationship Managers to provide any
assistance that you may require with respect to your business
and your trade needs.

Domestic Factoring

Through this product, our intention is to be an active partner in

the management of your company's supply/delivery chain.
Through domestic factoring, we could look at financing your
receivables from your buyers. Additionally we also undertake to
finance your vendor/supplier payments.

Receivables Finance can be structured with on a With Recourse

Basis (where we would be setting up lines on your company) or
on a Without Recourse Basis.

Payments of all your service and utility bills could be done

through our Vendor Finance product. These could include for
example, courier payments, electricity bills payment.

Through this mechanism we will pay out your service provider

on the due date of the invoice/bill and collect the money from
you after a pre-determined credit period.
International Factoring

In international factoring there are usually two factors. The

export factor looks at financing the exporter and sales
administration (presenting invoices at the right time, collecting
payments being the key tasks). The import factor is interested in
evaluating the buyer, collecting the money on time at the same
time ensuring that he is protected against default.

International factoring encompasses all the four services, that is,

pre-payments, sales ledger administration, credit protection and
collections.

Guide to International Factoring:

1. The importer places the order for purchase of goods with

the exporter.
2. The exporter requests the Export Factor for limit approval

on the importer. Export Factor in

3. Turn forwards this request to an Import Factor in the

Importer's country. The Import Factor

4. Evaluates the Importer and conveys its approval to the

Export Factor who in turn conveys

5. Commencement of the Factoring arrangement to the

Exporter.

6. The exporter delivers the goods to the importer.

7. Exporter produces the documents to the Export Factor.

8. The Export Factor disburses funds to the Exporter upto the

prepayment amount decided and at the

9. Same time the forwards the documents to the Import factor

and the Importer.

10. On the due date of the invoice, the Importer pays the

Import Factor, who in turn remits this

11. Payment to the Export Factor.

12. The Export Factor applies the received funds to the

outstanding amount of the advance against

 13. The invoice. The exporter receives the balance

payment.

Function of a factor

1. Administration of sales ledger

The factor maintain sales ledger in respect of each client when the

sales transaction takes place an invoice is prepared in duplicate by the

client, One copy is given to customer and second copy is sent to the

factor. Entries are made in the ledger on open item method. Each
recipt is matched against the specific invoice.On any given date the

customer account indicate the various open invoices outstanding

.Periodec reports are sent by factor to the clint with respect to current

status of transaction,the periodicity of report is decided. Thus the

entire sales ledger administration responsibility of the client gets

transferred to factor.

2. Collection of Recivables

The main function of the factor is to collect the receivable on the

behalf of the client and to relieve him from all the botherations

problems associated with the collection . This way the clint can

concentrate on other major areas of his business on one hand and

reduce the cost of collection by way of saving in labour time and

efforts on the other hand. The factor possesses trained and experienced

personal, sophisticated infrastructure and improve technology which

helps him to make timely demands on the debtors to make payments.

3. Provision of Finance

Finance which is the life blood of a business, is made available easily

by the factor to the client. A factor purchased the book debts of his

client and debts are assigned in favour of the factor .75%to 80% of the

assigned debts is given as advance to the client by the factor.

4. Protection Against Risk

This sevices is provided where the debts are factored without

resources. The factor fixes the credit limit in respect of approved

customers. Within this limit the factor undertakes to purchase all trade

debts and assumes risk of default in payment by the customers. The

factor not only relives the client from the collection work but also

advises the client on the creditworthiness of potential customers . Thus

the factor helps the client in adopting better credit control policy. The

credit standing of the customers is assessed by the factors on the basis

of information collected from credit rating reports, bank reports, trade

reference, financial statement analysis and by calculating the

important ratios in respect of liquidity and probility position.

5. Advisory Services

These services arise out of theclose relationship between a factor and a

client. Since the factor have better knowledge and wide experience in

field of finance, and possess extensive credit information about

customers standing they provide various advisory services on the

matters relating to:

 I. Customer’s preferences regarding the clients products.

II. Changes in marketing polices of the competitors.

III. Suggest improvements in the procedures adopted for

invoicing, delivery and sales return.

IV. Helping the clients for raising finance from banks /financial

institutions, etc.

Discount Rate

In the beginning, the factoring industry had some relatively high discount

rates due to heavy expenses caused by costly litigation battles and limited

access to traditional investors. However, once state and federal legislation

was enacted, the industry’s interest rates decreased dramatically. There is

much confusion with the terminology “discount rate” because the term is

used in different ways. The discount rate referred to in a factoring

transaction is similar to an interest rate associated with home loans, credit

cards and car loans where the interest rate is applied to the payment

stream itself. In a factoring transaction, the factoring company knows the

payment stream they are going to purchase and applies an interest rate to
the payment stream itself and solves for the funding amount, as though it

was a loan. Discount rates from factoring companies to consumers can

range anywhere between under 9% up to over 18% but usually average

somewhere in the middle. Factoring discount rates can be a bit higher

when compared to home loan interest rates, due to the fact the factoring

transactions are more of a boutique product for investors opposed to the

mainstream collateralized mortgage transactions. One common mistake

in calculating the discount rate is to use “elementary school math” where

you take the funding/loan amount and divide it by the total price of all the

payments being purchased. Because this method disregards the concept

of time (and the time value of money), the resulting percentage is useless.

For example, the court in In Re Henderson Receivables Origination v.

Campos noted an annual discount rate of 16.8% where the annuitant

received $36,500 for the assignment of payments totaling $63,364.94

over 84 months (two monthly payments of $672.32 each, beginning

September 30, 2006 and ending on October 31, 2006; eighty-two monthly

payments of $692.49 each, increasing 3% every twelve months,

beginning on November 30, 2006 and ending on August 31, 2013).

However, had the court in Henderson Receivables Origination applied the

illogical formula of discounting from “elementary school math”

($36,500/ $63,364.94), the discount rate would have been an

astronomical (and nonsensical) 61%. [17]

SBI Factors and Commercial Services Pvt Ltd (SBI
FACTORS)

SBI Factors, a subsidiary of State bank of India (SBI) is one of

the leading factoring companies in India with an asset base of
Rs. 700.10 crores as on 30.09.2005. It was established in
February 1991 with the primary objective to provide domestic
factoring services to Small and Medium Enterprises (SMEs).
Factoring is a Collection and finance service designed to
improve the cash flow position of SMEs by turning their credit
invoices into ready cash. The major strength of the company is
that it has put in place a technology driven platform for offering
integrated receivables management. SBI and its Associates
Banks hold 70% stake in SBI Factors.

SBIF offers Domestic Factoring With Recourse and Without

Recourse. Purchase Bill Factoring, Factoring of Usance Bills
Under LC, Channel Financing of Dealers / Distributors and
Export Factoring Facilities. All its products have been well
received by its clients.

SBIF has ten branches all over the country and it has plans to
open three more branches during the year. It has achieved a
turnover of Rs. 1489.54 Crores with Prepayment Outstanding of
Rs. 459.35 crores for the year ended 31.03.2005. The profit
before tax was Rs. 9.64 crores and PAT Rs. 6.12 Crores for the
year 2004-05. It has recorded a NIL NPA position as at
31.03.2005. It has declared a dividend of 8% during the year
2005. It has a market share of 40.30% as on 30.09.2005.