SHAH ALAM KHAN ASHISH SRIVASTAVA (FINANCE)

Factoring

is a financial transaction where by a business sells its accounts receivable to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business.

 The

selling of a company's accounts receivable, at a discount, to a factor, who then assumes the credit risk of the account debtors and receives cash as the debtors settle their accounts. Also called accounts receivable financing.

 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 order or contracts.

SELLER(BANK)

Buyer(customer)

factor

 Follow-up and collection of Receivables

from

Clients. Purchase of Receivables with or without recourse. Help in getting information and credit line on customers (credit protection). Sorting out disputes, if any, due to his relationship with Buyer & Seller.

 Client concludes a credit sale with a customer.

Factor maintains the customers account and

follows up for payment.

Factor makes the final payment to the Client

when the account is collected or on the guaranteed payment date.

 Factor charges Commission (as a

flat percentage of value of Debts purchased) (0.50% to 1.50%)

For making immediate part payment, interest

charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks.
Commission is collected up-front

Recourse Factoring
Non-recourse Factoring Maturity Factoring Domestic and Export Factoring

Up to 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.

Factor purchases Receivables on the condition that the Factor has no recourse to the Client, if the debt turns out to be non-recoverable. 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.

Factor does not 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.

It is similar to domestic factoring except that there are four parties, viz., a) Exporter b) Export Factor c) Import Factor d) Importer
It is also called two-factor system of factoring. Exporter (Client) enters into factoring arrangement with Export Factor in his country and assigns to him export receivables. Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & collection of payment for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import Factor. Import Factor collects payment and remits to Export Factor who passes on the proceeds to the Exporter after adjusting his advance, if any. Where foreign currency is involved, Factor covers exchange risk also.

Banks reluctance to provide factoring services .

Banks resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines). Problems in recovery.

Factoring requires assignment of debt which attracts Stamp Duty.

Cost of transaction becomes high.

Counter party credit risk related to clients and risk covered debtors. Risk covered debtors can be reinsured, which limit the risks of a factor. Trade receivables are a fairly low risk asset due to their short duration. External fraud by clients: fake invoicing, mis-directed payments, pre-invoicing, not assigned credit notes, etc. A fraud insurance policy and subjecting the client to audit could limit the risks. Legal, compliance and tax risks: large number of applicable laws and regulations in different countries. Operational risks, such as contractual disputes. Uniform Commercial Code securing rights to assets. IRS liens associated with payroll taxes etc. ICT risks: complicated, integrated factoring system, extensive data exchange with client.

Prep by-Ashish Srivastava Shah alam khan