Factoring Forfaiting Theory
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Transcript of Factoring Forfaiting Theory
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhINTRODUCTION
Factoringis a financial transaction whereby abusiness sells its accounts receivable
(i.e., invoices) to a third party (called a factor) ata discount in exchange for immediate moneywith which to finance continued business.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Factoring means an arrangement between afactor and his client which includes at leasttwo of the following services to be providedby the factor-
1)Finance2)Maintenance of accounts
3)Collection of debts
4)Protection against credit risk
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhFactoring Services - Concept
Definition:
Factoring is defined as acontinuing legalrelationship between a financial institution
(the factor) and a business concern (theclient), selling goods or providing servicesto trade customers (the customers) onopen account basis whereby the Factorpurchases the clients book debts(accounts receivables) either with orwithout recourse to the client and inrelation thereto controls the creditextended to customers and administersthe sales ledgers. 3
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhFactoring functions..
It is purchasing & collection theclients a/cs receivables (with orwithout recourse),
Sales Ledger management Credit investigation & undertaking of
risks
Provision of finance against debts Rendering consultancy services
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhFactoring Services - Concept
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Client Customer
Factor
Order placed
Deliver of goods
Client submits invoice
Factor-Prepayment
Monthly statements
Customer pays
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhWHY A FIRM USE
FACTORING
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.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhSERVICES OFFERED BY A
FACTORa) Follow-up and collection of Receivables from
Clients.
b) Purchase of Receivables with or without recourse.
c) Help in getting information and credit line oncustomers (credit protection)
d) Sorting out disputes , due to his relationship withBuyer & Seller.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhPROCESS INVOLVED IN
FACTORINGa) Client concludes a credit sale with a customer.
b) Client sells the customers account to the Factor andnotifies the customer.
c) Factor makes part payment (advance) against accountpurchased, after adjusting for commission and intereston the advance.
d) Factor maintains the customers account and follows upfor payment.
e) Customer remits the amount due to the Factor.
f) Factor makes the final payment to the Client when theaccount is collected or on the guaranteed payment date.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhMECHANICS OF FACTORING
a) The Client (Seller) sells goods to the buyer and preparesinvoice with a notation that debt due on account of thisinvoice is assigned to and must be paid to the Factor(Financial Intermediary).
b) The Client (Seller) submits invoice copy only with DeliveryChallan showing receipt of goods by buyer, to the Factor.
c) The Factor, after scrutiny of these papers, allows payment(,usually up to 80% of invoice value). The balance isretained as Retention Money (Margin Money). This is alsocalled Factor Reserve.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
a) The drawing limit is adjusted on a continuous basis after
taking into account the collection of Factored Debts.
b) Once the invoice is honored by the buyer on due date, theRetention Money credited to the Clients Account.
c) Till the payment of bills, the Factor follows up the payment
and sends regular statements to the Client.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhCHARGES FOR FACTORING
SERVICESa) Factor charges Commission (as a flat percentage of value of
Debts purchased) (0. 5 0% to 1. 5 0%)
b) Commission is collected up-front.
c) For making immediate part payment, interest charged. Interest
is higher than rate of interest charged on Working Capital
Finance by Banks.
d) If interest is charged up-front, it is called discount.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhTYPES OF FACTORING
a) Recourse Factoring.
b) Non-recourse Factoring.
c) Maturity Factoring.
d) Cross-border Factoring.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhRECOURSE FACTORING
a) Up to 75 % to 85 % of the Invoice Receivable isfactored.
b) Interest is charged from the date of advance to the date
of collection.c) Factor purchases Receivables on the condition that lossarising on account of non-recovery will be borne by theClient.
d) Credit Risk is with the Client.
e) Factor does not participate in the credit sanctionprocess.
f) In India, factoring is done with recourse.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhNON-RECOURSE FACTORING
a) Factor purchases Receivables on the condition that the Factor hasno recourse to the Client, if the debt turns out to be non-recoverable.
b) Credit risk is with the Factor.
c) Higher commission is charged.
d) Factor participates in credit sanction process and approves creditlimit given by the Client to the Customer.
e) In USA/UK, factoring is commonly done without recourse.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhMATURITY FACTORING
a) Factor does not make any advance payment to the Client.
b) Pays on guaranteed payment date or on collection of
Receivables.
c) Guaranteed payment date is usually fixed taking intoaccount previous collection experience of the Client.
d) Nominal Commission is charged.
e) No risk to Factor.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhCROSS - BORDER FACTORING
a) It is similar to domestic factoring except that there arefour parties, viz.,
b) a) Exporter,
c) b) Export Factor,
d) c) Import Factor, and
e) d) Importer.
f) It is also called two-factor system of factoring.
g) Exporter (Client) enters into factoring arrangement withExport Factor in his country and assigns to him exportreceivables.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarhexport Factor enters into arrangement with
Import Factor and has arrangement for creditevaluation & 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 afteradjusting his advance, if any.
Where foreign currency is involved, Factor coversexchange risk also.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Advantages of Factoring
Factoring provides a large and quick boost to
cashflow.
there are many factoring companies, so prices
are usually competitive it can be a cost-effective way of outsourcing your
sales ledger while freeing up your time to
manage the business
it assists smoother cashflow and financial
planning
some customers may respect factors and pay
more quickly 18
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
factors may give you useful information about
the credit standing of your customers and theycan help you to negotiate better terms with your
suppliers
factors can prove an excellent strategic - as well
as financial - resource when planning business
growth
you will be protected from bad debts if you
choose non-recourse factoring - see the page inthis guide on recourse factoring and non-
recourse factoring
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http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCES -
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
cash is released as soon as orders are invoiced
and is available for capital investment and
funding of your next orders
factors will credit check your customers and canhelp your business trade with better quality
customers and improved debtor spread
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Demerits of Factoring The cost will mean a reduction in your profit
margin on each order or service fulfilment.
It may reduce the scope for other borrowing -
book debts will not be available as security. Factors will restrict funding against poor quality
debtors or poor debtor spread, so you will need
to manage these funding fluctuations.
It may be difficult to end an arrangement with a
factor as you will have to pay off any money they
have advanced you on invoices if the customer
has not paid them yet. 21
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Some customers may prefer to deal directly with
you.
How the factor deals with your customers will
affect what your customers think of you. Makesure you use a reputable company that will not
damage your reputation.
You have to pay extra to remove your liability forbad debtors.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhFACTORING IN INDIA
a) Kalyana Sundaram Committee recommendedintroduction of factoring in 1989.
b) Banking Regulation Act, 1949, was amended in 1991 forBanks setting up factoring services.
c) SBI/ Canara Bank have set up their FactoringSubsidiaries:-
d) SBI Factors Ltd., (April, 1991) ( an asset base of Rs1908.00 corers as on March 31, 2008, highest in India)
e) Canara Bank Factors Ltd., (August, 1991).f) RBI has permitted Banks to undertake factoring services
through subsidiaries.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhWhy we need Factoring?
For Smooth cash flow
For meeting working capital needs
Overcome the situation from high cost
of capital and reduced profit
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhForfaiting..
It is a highly flexible technique that allows an Exporter
to grant attractive credit terms to foreign Buyers,
without tying up cash flow or assuming the risks of
possible late payment or default. Simultaneously, the
Exporter is fully protected against interest and/or
currency rates moving unfavourably during the credit
period
Forfaiting is a highly effective sales tool, whichsimultaneously improves cash-flow and eliminates
risk.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhSix Parties in Forfaiting
1. Exporter (India)
2. Importer (Abroad)
3. Exporters Bank (India)
4. Importers/Avalising Bank (Abroad)
5. EXIM Bank (India )
6. Forfaiter (Abroad)
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhMechanism
1. The exporter and importer negotiate theproposed export sale contract. Then the
exporter approaches the forfaiter to ascertain
the terms of forfaiting.
2. The forfaiter collects details about theimporter, supply and credit terms,
documentation etc.
3. Forfaiter ascertains the country risk and creditrisk involved.
.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
4. The forfaiter quotes the discount rate.
5. The exporter then quotes a contract price to theoverseas buyer by loading the discount rate,
commitment fee etc. on the sale price of the
goods to be exported.
6. The exporter and forfaiter sign a contract.
7. Export takes place against documents
guaranteed by the importers bank.
8. The exporter discounts the bill with the forfaiter
and the latter presents the same to the importer
for payment on due date or even sell it in
secondary market. 29
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Costs of forfaitingThe forfaiting transaction has typically three costelements:
1. Commitment fee, payable by the exporter to
the forfaiter for latters commitment to execute aspecific forfaiting transaction at a firm discount
rate with in a specified time.
2. Discount fee, interest payable by the exporter
for the entire period of credit involved anddeducted by the forfaiter from the amount paid to
the exporter against the availised promissory
notes or bills of exchange.
3. Documentation fee.30
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Benefits of forfaiting1. It frees the exporter from political or
commercial risks from abroad.
2. Forfaiting offers without recourse finance toan exporter. It does not effect the exporters
borrowing limits/capacity.
3. Forfaiting relieves the exporter from
botheration of credit administration and
collection problems.
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AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
4. Forfeiting is specific to a transaction. It does
not require long term banking relationship with
forfeiter.
5. Exporter saves money on insurance costs
because forfeiting eliminates the need for export
credit insurance.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhBenefits to Exporters
Converts a Deferred Paymentexport into a
cash transaction, improves liquidity
Frees Exporter from cross-border political or
commercial risks associated
Finances upto 100 percentof export value
It is a Without Recourse finance
Hedges against Interest and Exchange Risks
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhFACTORING vs. FORFAITING
POINTS OFDIFFERENCE
FACTORING FORFAITING
Extent of Finance Usually 75 80% of thevalue of the invoice
100% of Invoice value
CreditWorthiness
Factor does the creditrating in case of non-recourse factoringtransaction
The Forfaiting Bankrelies on thecreditability of theAvalling Bank.
Services provided Day-to-day administrationof sales and other alliedservices
No services areprovided
Recourse With or without recourse Always withoutrecourse
Sales By Turnover By Bills
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhDIFFERENCE BETWEEN
FACTORING AND FORFAITING1.Suitable for ongoing open
account sales, not backed
by LC or accepted bills or
exchange.
2. Usually provides financingfor short-term credit period
of upto 180 days.
1. Oriented towards single
transactions backed by LC
or bank guarantee.
2. Financing is usually for
medium to long-term creditperiods from 180 days upto
7 years though shorterm
credit of 30180 days is
also available for large
transactions.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhDIFFERENCE BETWEEN
FACTORING AND FORFAITING3.Requires a continuous
arrangements betweenfactor and client, wherebyall sales are routed throughthe factor.
4. Factor assumesresponsibility for collection,helps client to reduce hisown overheads.
3. Seller need not route orcommit other business tothe forfaiter. Deals areconcluded transaction-wise.
4. Forfaiters responsibilityextends to collection offorfeited debt only. Existingfinancing lines remainsunaffected.
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhDIFFERENCE BETWEEN
FACTORING AND FORFAITING5. Separate charges are
applied for
financing
collection
administration
credit protection and provision of information.
5. Single discount charges isapplied which depend on
guaranteeing bank andcountry risk,
credit period involved
and currency of debt.
Only additional charges iscommitment fee, if firmcommitment is requiredprior to draw down duringdelivery period.
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A G O A
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhDIFFERENCE BETWEEN
FACTORING AND FORFAITING6. Service is available for
domestic and exportreceivables.
7. Financing can be with
or without recourse; thecredit protectioncollection andadministration services
may also be providedwithout financing.
6. Usually available forexport receivables onlydenominated in anyfreely convertible
currency.7. It is always without
recourse andessentially a financing
product.
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AMITY GLOBAL
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AMITY GLOBAL
BUSINESS SCHOOL ChandigarhList of some Forfaiters
Standard Bank, London Hong Kong Bank
Indo Aval
ABN AMRO Bank
Meghraj Financial Services
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