Factoring and Forfeting

8/14/2019 Factoring and Forfeting

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Introduction

Factoring is a type of financial service provided by the specialist organizations. When small scale firms sell on credit basis, collectionof receivable poses a problem. In that case factoring organizations play an important role in collection of debtors. Factoring involvessale of receivables to specialized firm, called factors. Factors collect receivables and also advance cash against receivables to solve theclient firm’s liquidity problem. For providing their services, they charge interest on advance and commission for other services

Definition

“Factoring is a service involving the purchase by a financial organization, called a factor, of receivables owned to manufacturer and

distributors by their customers, with the factor assuming full credit and collection responsibilities.”

“Factoring is a service of financial nature involving the conversion of credit bills into cash.”

Characteristics of factoring

• Usually the period for factoring is 90 to 150 days. Some factoring companies allow even more than 150 days.

• Factoring is considered to be a costly source of finance compared to other sources of short term borrowings.

• Factoring receivables is an ideal financial solution for new and emerging firms without strong financials. This is because creditworthiness is evaluated based on the financial strength of the customer (debtor). Hence these companies can leverage on thefinancial strength of their customers.

• 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 theagreement.

• 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 thecustomer etc. The cost of factoring varies from 1.5% to 3% per month depending upon the financial strength of the client'scustomer

• 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 costis charged (it varies like 1% for the first month and 2% afterwards).

Mechanism

A factor provides finance to his client upto a certain percentage of the unpaid invoices which represent the sales of goods or services

to approved customers. The mechanism of the factoring scheme is as follows:

➢ There should be a factoring arrangement (invoice purchasing arrangement) between the client(which sells the goods and servicesto trade customer in credit) and the factor, which is the financing organization.

➢ Whenever the client sells goods to the trade customers on credit he prepares invoices in the usual way.➢ The goods are sent to the buyers without raising a bill of exchange but accompanied by an invoice.➢ The debt due by the purchaser to the client is assigned to the factor by advising the trade customers to pay the amount due to the

client, to the factor.➢ The client hands over the invoices to the factor under cover of a schedule of offer along with the copies of invoices and receipted

delivery challans.➢ The factor makes an immediate payment upto 80% of the assigned invoices and the balance 20% will be paid on realization of the

debt.Functions

➢ Purchase and collection of debt➢ Sales ledger management➢ Credit investigation and undertaking of credit risk ➢ Provision of finance against debts➢ Rendering consulting services

Advantages

Benefits of Factoring to Clients

• Under the factoring arrangement the client receives prepayment upto 80-90 percent of the invoice value immediately and the balance amount after the maturity period. This helps the client to improve cash flow position which enables him to have betterflexibility in managing working capital funds in an efficient and effective manner.



• If the client avails the services of the factor in respect of sales ledger administration and collection of receivables, he need nothave any administrative set up for this purpose. Naturally this will result into a substantial saving in time and cost of maintainingown sales ledger administration and collecting receivables from the customer. Thus, it will reduce administrative cost and time.

• When without recourse factoring arrangement is made, the client can eliminate the losses on account of bad debts. This will helphim to concentrate more on maximizing production and sales. Thus, it will result in increase in sales, increase in business andincrease in profit.

• The client can avail advisory services from the factor by virtue of his expertise and experience in the areas of finance andmarketing. This will help the client to improve efficiency and productivity of his organization. Besides this, with the help of data

base, the factor can readily provide information regarding product design/mix, prices, market conditions etc., to the client whichcould be useful to him for business decisions.

• The above mentioned benefits will accrue to the client provided he develops a better business relationship with the factor and bothof them have mutual trust in each other.

Disadvantages of Factoring

• Image of the client may suffer as engaging a factoring agency is not considered a good sign of efficient management.• Factoring may not be of much use where companies or agents have one time sales with the customers.• Factoring increases cost of finance and thus cost of running the business.• If the client has cheaper means of finance and credit (where goods are sold against advance payment), factoring may not be

useful.



FactorClientCustomerPays the amount (In

recourse type customer pays

through client)

credit sale of

goods

InvoiceSubmit

invoice copy

Payment up

to 80%

initially

Pays the

balance amount

Factoring and Forfeting

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