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Factoring & Forfaiting
Junior level presentation
Compiled by V.V.S. Rao
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Factoring
Factoring means undertaking to finance andcollect
account Receivables
Can be in domestic or international trade
Usually undertaken by a Bank or a Financial
Institution
The buyer and seller usually have long termrelationship
Factoring enables the companies to sell their
outstanding book debts for cash
Introduction
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Factoring
Process It is an ongoing arrangement between a ´Sellerµ (Customer
of "Factor") and ´Factorµ (the banker)
Sales invoices will be raised on ´Open Accountµ basis on the
Buyers by the Sellers.
These invoices are regularly assigned by Sellers (Customersof ´Factorµ) to the ´Factorµ
The ´Factorµ will undertake:
Financing
Collection
Sales Ledger Administration
The ´Seller ´ assigns his right of recovery on the invoices to
the ´Factorµ at a discount to raise short term working capital
finance
The ³Factor´ may or may not accept the underlying
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Factoring Types of factoring
There are two types of factoring:
i. Recourse factoring (with recourse)
ii. Non-Recourse factoring (without recourse)
Recourse factoring:
The Factor has got the right to recover the amount advanced from
the Seller (Client of "Factor") in case of non-payment of the invoice
by the buyer.
Non-Recourse factoring:
In case of non-payment, the ´Factorµ will bear the risk of bad debts
This means the ´Factorµ provides to the client the both finance and
credit protection
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FactoringOperation
The ´Factorµ operates by buying from the sellingcompany, their invoiced debts.
These are purchased usually with credit
protection by the ´Factorµ
The ´Factorµ is responsible for:
Credit control
Collection Sales accounting work
Thus management of the company can
concentrate on production and sales
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FactoringOperation
Various MIS reports such as will be provided by the´Factorµ to the seller:
Debtors ageing analysis
Weekly statement of accounts
Sales analysis Statement of outstanding invoices
Usually before providing advance payments to the
supplier; an agreement is entered with the supplier for
assigning the debts
Sub-limits for each purchaser could be fixed by the
´Factorµ
´Factorµ will register their right of assignment with
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Factoring Advantages of Factoring
Factoring replaces high cost market credit and enablespurchases on cash basis for availing cash discounts
The seller gets instant finance against invoices
Low margin (normally 20%) which will improve cash flowof seller
Seller gets large credit / grace period
Each invoice is followed-up for payment by the ´Factorµ tillpayment is made by the due date and even thereafter.
MIS reports and Ledger administration is taken care by
the ´Factorµ
´ µ
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FACTORING
VS
BILLS DISCOUNTING
BILL DISCOUNTING
1. Bill is separately examinedand discounted.
2. Financial Institution doesnot have responsibility ofSales LedgerAdministration andcollection of Debts.
3. No notice of assignmentprovided to customers ofthe Client.
FACTORING
1. Pre-payment made againstall unpaid and not dueinvoices purchased byFactor.
2. Factor has responsibilityof Sales LedgerAdministration andcollection of Debts.
3. Notice of assignment isprovided to customers ofthe Client.
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VS
BILLS DISCOUNTING (CONTD«)
BILLS DISCOUNTING
4. Bills discounting is usually
done with recourse.
5. Financial Institution can get
the bills re-discountedbefore they mature forpayment.
FACTORING
4. Factoring can be donewithout or without recourseto client. In India, it is donewith recourse.
5. Factor cannot re-discount
the receivable purchasedunder advanced factoringarrangement.
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ForfaitingDefinition
Forfaiting is a means of finance (credit)
which an exporter of goods avails
from an intermediary called the ´Forfaiterµ
against the export receivables
without the obligation to repay the credit
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ForfaitingPurpose
Forfaiting is used in International trade transactions
It is nothing but discounting of trade receivables such
as:
Drafts drawn under Letters of Credit Bills of Exchange
Promissory Notes
Any other freely negotiable instruments
Forfaiting is done on ³No Recourse´ basis
i.e. In case if importer / drawee fails to make payment
on the due date the ³Forfaiter´ can not claim from the
exporter refund of the credit provided
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ForfaitingOperation
Exporter can grant attractive credit terms to foreignbuyers, without sacrificing his own cash flows.
Exporter is free of the risks of possible late payment
or default by the buyer (Importer)
Exporter is fully protected against volatility in
interest rates and exchange rates.
The above is possible since all these risks are passedon to the Forfaiter
Forfaiting is a highly effective sales tool, which
simultaneously improves cash flow and eliminates
risk for the exporter
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Forfaiting Mechanism of Forfaiting
Exporter enters into contract with Importer
Adequate credit to pay the bills is given by
exporter
Exporter will inform Importer that he willbe assigning the bills to Forfaiter
Importer will arrange with his banker forissue of Letter of credit in favour of exporter
Exporter enter into Forfaiting contract with
ForfaiterContd in Next Slide)
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Forfaiting Mechanism of Forfaiting («..contd)
Actual export takes place
Bill of exchange is drawn by the Exporter
(Seller)
Such Bill of exchange will be accepted bythe LC Issuing Bank in case of LC bills orby the Bankers of the Importer in othercases.
Forfaiter sends these documents to theImporter·s Bank , which in turn notifiesthe receipt to Forfaiter
Forfaiter makes payment of 100% of billvalue to the Exporter after deductingdiscount and other incidental chargesContd in Next Slide)
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Forfaiting Mechanism of Forfaiting («..contd)
Forfaiter in exchange of payment hemade to the Exporter, takes over theresponsibility for claiming the debtamount from the Importer
Forfaiter either holds the bill of exchange till maturity (as investment)or sells them to another investor on anon-recourse basis
The holder of the Bills of exchangethen presents each receivable to theBank at which they are payable on
respective due dates.
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Forfaiting Advantages of Forfaiting
Finance tothe extent of
100% of invoicevalue
Exporter is
free fromanyresponsibilit
y i.e. non-recourse
basisfinancing
Exporter¶slines of
credit with his banker
become free
Improvescash flow of
the exporter
Savesadministrati
on costs
Increasestrade
opportunity
Exporter
avoidsvarious riskslike interest-
rate risk,currency
risk, creditrisk and
political risk
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FACTORING VS. FORFAITING
POINTS OFDIFFERENCE
FACTORING FORFAITING
Extent of Finance Usually 75 ² 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 administration
of sales and other alliedservices
No services are
provided
Recourse With or without recourse Always withoutrecourse
Sales By Turnover By Bills
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COMPARATIVE ANALYSIS
BILLSDISCOUNTED
FACTORING FORFAITING
1. Scrutiny Individual SaleTransaction
Service of SaleTransaction
Individual SaleTransaction
2. Extent ofFinance Upto 75 ² 80% Upto 80% Upto 100%
3. Recourse With Recourse With orWithoutRecourse
WithoutRecourse
4. SalesAdministration
Not Done Done Not Done
5. Term Short Term Short Term Medium Term
6. ChargeCreation
Hypothecation Assignment Assignment
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