FACTORING AND FORFAITING

FACTORING AND FORFAITING

Factoring is of recent origin in Indian Context. Kalyana Sundaram Committee recommended introduction of factoring in 1989. Banking Regulation Act, 1949, was amended in 1991 for Banks setting up factoring services. SBI/Canara Bank have set up their Factoring Subsidiaries: SBI Factors Ltd., (April, 1991) CanBank Factors Ltd., (August, 1991).

RBI has permitted Banks to undertake factoring services through subsidiaries.

WHAT IS FACTORING ?
Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on the understanding that the Factor will pay for the Book Debts as and when they are collected or on a guaranteed payment date

PROCESS OF FACTORING

CLIENT

CUSTOMER

FACTOR

So, a Factor is,

a) b) c)

A Financial Intermediary That buys invoices of a manufacturer or a trader, at a discount, and Takes responsibility for collection of payments.

The parties involved in the factoring transaction are:a) b) c) Supplier or Seller (Client) Buyer or Debtor (Customer) Financial Intermediary (Factor)

d)

Normally, the Factor makes a part payment (usually upto 80%) immediately after the debts are purchased thereby providing immediate liquidity to the Client.

SERVICES OFFERED BY A FACTOR

1.
2. 3.

Follow-up and collection of Receivables from

Clients.

Help in getting information and credit line on customers Purchase of Receivables with or without recourse.

PROCESS INVOLVED IN FACTORING

1. Client concludes a credit sale with a customer. 2. Client sells the customers account to the Factor and notifies the customer. 3. Factor makes part payment (advance) against account purchased, after adjusting for commission and interest on the advance. 4. Factor maintains the customers account and follows up for payment. 5. Customer remits the amount due to the Factor. 6. Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date.

CHARGES FOR FACTORING SERVICES

Factor charges Commission (0.50% to 1.50%) If interest is charged.

TYPES OF FACTORING
Recourse Factoring Non-recourse Factoring

--------------------------------------- Maturity Factoring Cross-border Factoring

RECOURSE FACTORING
Upto 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.

NON-RECOURSE FACTORING
Factor purchases Receivables on the condition that the Factor has no recourse to the Client, if the debt turns out to be nonrecoverable. Credit risk is with the Factor. Higher commission is charged. Factor participates in credit sanction process and approves credit limit given by the Client to the Customer.

MATURITY FACTORING
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.

CROSS - BORDER FACTORING

It is similar to domestic factoring except that there are four parties, viz., a) Exporter, b) Export Factor, c) Import Factor, and d) Importer. It is also called two-factor system of factoring. Ffm13e instructor

FACTORING vs BILLS DISCOUNTING

1. BILL DISCOUNTING Bill is separately examined and discounted. 1. FACTORING Pre-payment made against all unpaid and not due invoices purchased by Factor. Factor has responsibility of Sales Ledger Administration and collection of Debts.

2.

Financial Institution does not have responsibility of Sales Ledger Administration and collection of Debts. No notice of assignment provided to customers of the Client.

2.

3.

3.

Notice of assignment is provided to customers of the Client.

FACTORING vs BILLS DISCOUNTING

BILLS DISCOUNTING Bills discounting is usually done with recourse. FACTORING Factoring can be done without or without recourse to client. In India, it is done with recourse.

4.

4.

5.

Financial Institution can get the bills re-discounted before they mature for payment.

5.

Factor cannot re-discount the receivable purchased under advanced factoring arrangement.

STATUTES APPLICABLE TO FACTORING

a) b) Factoring transactions in India are governed by the following Acts:Indian Contract Act Sale of Goods Act

c)
d)

Transfer of Property Act

Banking Regulation Act.

e)

Foreign Exchange Regulation Act.

WHY FACTORING HAS NOT BECOME POPULAR IN INDIA

Banks reluctance to provide factoring services Problems in recovery. Factoring requires assignment of debt which attracts Stamp Duty. Banks resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines). Cost of transaction becomes high.

FORFAITING
Forfaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him.

It is different from International Factoring in as much as it deals with receivables relating to deferred payment exports, while Factoring deals with short term receivables.

CHARACTERISTICS OF FORFAITING
Converts Deferred Payment Exports into cash transactions, providing liquidity and cash flow to Exporter. Absolves Exporter from Cross-border political or conversion risk associated with Export Receivables. Finance available upto 100% (as against 75-80% under conventional credit) without recourse. Acts as additional source of funding and hence does not have impact on Exporters borrowing limits. It does not reflect as debt in Exporters Balance Sheet. Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise.

CHARACTERISTICS OF FORFAITING
(contd.) Exporter is freed from credit administration. Provides long term credit unlike other forms of bank credit. Saves on cost as ECGC Cover is eliminated. Simple Documentation as finance is available against bills. Forfait financer is responsible for each of the Exporters trade transactions. Hence, no need to commit all of his business or significant part of business. Forfait transactions are confidential.

COSTS INVOLVED IN FORFAITING

Commitment Fee:- Payable to Forfaiter by Exporter in consideration of forefaiting services. Commission:- Ranges from 0.5% to 1.5% per annum. Discount Fee:- Discount rate based on LIBOR for the period concerned. Documentation Fee:- where elaborate legal formalities are involved. Service Charges:- payable to Exim Bank.

FACTORING vs. FORFAITING

POINTS OF DIFFERENCE FACTORING FORFAITING 100% of Invoice value The Forfaiting Bank relies on the creditability of the Avalling Bank. No services are provided Always without recourse

Extent of Finance Usually 75 80% of the value of the invoice Credit Worthiness Factor does the credit rating in case of nonrecourse factoring transaction

Services provided Day-to-day administration of sales and other allied services Recourse With or without recourse

Question
A firm has a total credit sale of Rs. 80 lakhs and its average collection period is 80 days. The experience indicates that bad debt losses are around 1 % of credit sales. The firm spends Rs. 1,20,000 p.a. on administration of its credit sales. This cost includes salaries of one officer and two clerks who handle credit checking, collection etc. telephone and fax charges. Besides the firm borrows from bank against receivables at the rate of 16% p.a. which are avoidable costs. A factor is prepared to buy the firms receivables. He will charge 2 % commission. He will also pay advances against receivables to the firm at an interest rate of 18% after withholding 10% as reserve. Should firm avail factoring services? (Assume 360 days in a year. Bank finances only 50% of receivables )