FACTORING
DEFINITION:
Factoring is a financial service in which the business entity
sells its bill receivables to a third party at a discount in
order to raise funds. It differs from BILL/INVOICE
DISCOUNTING. The concept of Bill/Invoice discounting
involves, getting the invoice discounted at a certain rate to
get the funds, whereas the concept of factoring is broader.
Factoring involves the selling of all the accounts receivable
to an outside agency. Such an agency is called a factor
FACTORING
CONCEPT:
The seller makes the sale of goods or services and generates
invoices for the same. The business then sells all its invoices
to a third party called the factor. The factor pays the seller,
after deducting some discount on the invoice value. The
rate of discount in factoring ranges from 2 to 6 percent.
However, the factor does not make the payment of all
invoices immediately to the seller. Rather, it pays only up to
75 to 80 percent of the invoice value after deducting the
discount. The remaining 20 to 25 percent of the invoice
value is paid after the factor receives the payments from the
seller’s customers. It is called factor reserve.
FACTORING
TYPES:
• There are various types of Factoring such as
• 1. Recourse factoring
• 2. Non recourse factoring
• 3. Domestic factoring
• 4. Cross border factoring
FACTORING
FUNCTIONS OF FACTOR:
1. MAINTENANCE OF SALES LEDGER
2. FINANCING
3. CREDIT PROTECTION
4. COLLECTION OF MONEY
FACTORING
FACTORING PROCESS:
• The seller sells the goods to the buyer and raises the invoice on the customer.
• The seller then submits the invoice to the factor for funding. The factor
verifies the invoice.
• After verification, the factor pays 75 to 80 percent to the client/seller.
• The factor then waits for the customer to make the payment to him.
• On receiving the payment from the customer, the factor pays the remaining
amount to the client.
• Fees charged by factor or interest charged by a factor may be upfront i.e. in
advance or it may be in arrears. It depends upon the type of factoring
agreement.
• In case of non – recourse factoring services factor bears the risk of bad debt
so in that case factoring commission rate would be comparatively higher.
• The rate of factoring commission, factor reserve, the rate of interest, all of
them is negotiable. These are decided depending upon the financial situation
of the client.
FACTORING
FACTORING
ADVANTAGES OF FACTORING:
• It reduces the CREDIT RISK of the seller.
• The WORKING CAPITAL CYCLE runs smoothly as the factor
immediately provides funds on the invoice.
• Sales ledger maintenance by the factor leads to a reduction of cost.
• Improves/maintains liquidity and cash flow in the organization.
• It leads to improvement of cash in hand. This helps the business to
pay its creditors in a timely manner which helps in negotiating
better discount terms.
• It reduces the need for the introduction of new capital in the
business.
• There is a saving of administration or collection cost.
FACTORING
DISADVANTAGES OF FACTORING:
• Factor collecting the money on behalf of the company can
lead to stress in the company and the client relationships.
• The cost of factoring is very high.
• Bad behaviour of factor with the debtors can hamper
the goodwill of the company.
• Factors often avoid taking responsibility for risky debtors. So
the burden of managing such debtor is always in the
company.
• The company needs to show all the details about company
customers and sales to factor.
FACTORING
Example:
A factoring client has a Rs 1,00,000 invoice that
they need to finance. This invoice is from a
pre-approved customer who has great credit
and often pays in 30 days or less.
The client gets the following terms from the
factoring company:
• Advance rate: 85%
• Fees: 2 % per 30 days
FACTORING
• 1. The client submits the Rs 1,00,000 invoice to the
factoring company (FACTOR)
• 2. The FACTOR processes the invoice and deposits Rs
85,000 in the client’s account (Rs1,00,000 x 85% advance
rate).
• 3. After 30 days, the customer pays Rs 1,00,000.
• 4. The factoring company processes the payment and
settles the account. The fee for 30 days is Rs 2,000 (Rs
1,00,000 x 2%).
• 5. The factor rebates Rs 13,000 (the remaining Rs 15,000
less the Rs 2,000 fee) and deposits the money to the
client’s bank account.