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) A Financial Intermediary
b) That buys invoices of a manufacturer or a trader, at a discount, and
c) Takes responsibility for collection of payments.
The parties involved in the factoring transaction are:-
d) Supplier or Seller (Client)
e) Buyer or Debtor (Customer)
f) Financial Intermediary (Factor)
g) 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. Follow-up and collection of Receivables from Clients.
2. Help in getting information and credit line on customers
3. Purchase of Receivables with or without recourse.
PROCESS INVOLVED IN
FACTORING
1. Client concludes a credit sale with a customer.
2. Client sells the customer’s 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 customer’s 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 non-recoverable.
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.
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instructor
FACTORING vs
BILLS DISCOUNTING
BILL DISCOUNTING FACTORING
1. Bill is separately examined 1. Pre-payment made against
and discounted. all unpaid and not due
invoices purchased by
Factor.
2. Financial Institution does not 2. Factor has responsibility of
have responsibility of Sales Sales Ledger Administration
Ledger Administration and and collection of Debts.
collection of Debts.
3. No notice of assignment 3. Notice of assignment is
provided to customers of the provided to customers of the
Client.
Client.
FACTORING vs
BILLS DISCOUNTING
BILLS DISCOUNTING FACTORING
4. Bills discounting is usually 4. Factoring can be done
done with recourse. with or without recourse
to client. In India, it is
done with recourse.
5. Financial Institution can
5. Factor cannot re-discount
get the bills re-discounted
the receivable purchased
before they mature for
under advanced factoring
payment.
arrangement.
STATUTES APPLICABLE TO
FACTORING
• Factoring transactions in India are governed by the following
Acts:-
a) Indian Contract Act
b) Sale of Goods Act
c) Transfer of Property Act
d) 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.
• Bank’s 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 Exporter’s borrowing limits. It does not reflect as debt in Exporter’s
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 Exporter’s 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 FACTORING FORFAITING
DIFFERENCE
Extent of Usually 75 – 80% of the 100% of Invoice
Finance value of the invoice value
Credit Factor does the credit The Forfaiting Bank
Worthiness rating in case of non- relies on the
recourse factoring creditability of the
transaction Avalling Bank.
Services Day-to-day No services are
provided administration of sales provided
and other allied services
Recourse With or without recourse Always 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 firm’s 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 )