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Evolution of factoring

The term factor has its origin from the Latin word,Facere meaning to get things done. The dictionary

defines a factor as an agent particularly a mercantile

agent. Factoring has a long fascinating history which

traces back through several centuries.

It is a financial service, where by an institution called

factor undertakes the task of r ealizing accounts

receivables such as book debts ,B/R, and managing

sundry debts and sales registers of commercial and

trading firms in the capacity of an agent for acommission,


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Factoring

Definition:

Factoring is defined as a continuing legalrelationship between a financial institution (thefactor) and a business concern (the client),selling goods or providing services to trade

customers (the customers) on open accountbasis whereby the Factor purchases the clientsbook debts (accounts receivables) either with orwithout recourse to the client and in relationthereto controls the credit extended to

customers and administers the sales ledgers.


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Explanation

It is the outright purchase of credit approvedaccounts receivables with the factor assuming

bad debt losses.

Factoring provid

es sal

es accounting s

ervic

e, us

e

of finance and protection against bad debts.

Factoring is a process of invoice discounting by

which a capital market agency purchases all

trade debts and offers resources against them.


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Different kinds of factoring services

Debt administration: The factor manages the sales ledger

of the client company. The client will be saved of the

administrative cost of book keeping, invoicing, credit

control and debt collection. The factor uses his

compute

r syste

m to re

nder t

hesal

es l

edg

eradministration services.

Credit Information: Factors provide credit intelligence to

their client and supply periodic information with various

customer-wise analysis.

Credit Protection: Some factors also insure against bad

debts and provide without recourse financing.


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Invoice Discounting or Financing : Factors advance 75%to 80% against the invoice of their clients. The clientsmark a copy of the invoice to the factors as and whenthey raise the invoice on their customers.


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Basically there are three parties to the factoring services as depicted

below:

Clientcustomer

factor

Buyer


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Services rendered by factor

Factor evaluated creditworthiness of the customer

(buyer of goods)

Factor fixes limits for the client (seller) which is anaggregation of the limits fixed for each of thecustomer (buyer).

Client sells goods/services.

Client assigns the debt in favor of the factor

Client notifies on the invoice a direction to thecustomer to pay the invoice value of the factor.


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Services rendered by factor

Client forwards invoice/copy to factor along withreceipted delivery challans.

Factor provides credit to client to the extent of 80% ofthe invoice value and also notifies to the customer

Factor periodically follows with the customerWhen the customer pays the amount of the invoice

the balance of 20% of the invoice value is passed tothe client recovering necessary interest and othercharges.

If the customer does not pay, the factor takesrecourse to the client.


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Benefits of factoring

The client will be relieved of the work relating to sales ledgeradministration and debt collection

The client can therefore concentrate more on planningproduction and sales.

The charges paid to a factor which will be marginally high at 1to 1.5% than the bank charges will be more than compensatedby reductions in administrative expenditure.

This will also improve the current ratio of the client andconsequently his credit rating.

The subsidiaries of the various banks have been rendering thefactoring services.

The factoring service is more comprehensive in nature thanthe book debt or receivable financing by the bankers.


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Forfeiting

The forfeiting owes its origin to a French term forfeit which

means to forfeit (or surrender) ones rights on something tosome one else.

Under this mode of export finance, then exporter forfeits hisrights to the future receivables and the forfeiter loses recourseto the exporter in the event of non-payment by the importer.


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Methodology

It is a trade finance extended by a forfeiter to an exporter/seller for

an export/sale transaction involving deferred payment terms over

a long period at a firm rate of discount.

Forfeiting is generally extended for export of capital goods,

commodities and services where the importer insists on supplies

on credit terms.

The exporter has recourse to forfeiting usually in cases where the

credit is extended for long durations but there is no prohibition for

extending the facility where the credits are maturing in periods

less than one year.

Credits for commodities or consumer goods is generally for

shorter duration within one year. Forfeiting services are extended

in such cases as well.


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Mechanism

There are five parties in a transaction of forfeiting. These

are :

1.

Export

er

2. Exporters bank

3. Importer

4. Importers bank and

5. Forfeiter


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Mechanism

The exporter and importer negotiate the proposed export sale

contract. These are the preliminary discussions.

Based on these discussions the exporter approaches theforfeiter to ascertain the terms for forfeiting.

The forfeiter collects from exporter all the relevant details of

the proposed transaction, viz., details about the importer,supply and credit terms, documentation, etc., in order toascertain the country risk and credit risk involved in thetransaction..

Depending upon the nature and extent of these risks theforfeiter quotes the discount rate.

The exporter has now to take care that the discount rate isreasonable and would be acceptable to his buyer.


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Mechanism

He will then quote a contract price to the overseas buyer byloading the discount rate, commitment fee, etc., on the saleprice of the goods to be exported.

If the deals go through, the exporter and forfeiter sign acontract.

Export takes place against documents guaranteed by the

importers bank.

The exporter discounts the bill with the forfeiter and the

forfeiter presents the same to the importer for payment on

due date or even can sell it in secondary market.


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Documentation and cost

Forfeiting transaction is usually covered either by apromissory note or bill of exchange. In either case it hasto be guaranteed by a bank or, bill of exchange may beavailed by the importer bank.

The Avail is an endorsement made on bill of exchange

or promissory note by the guaranteeing bank by writingper avail on these documents under properauthentication.

The forfeiting cost for a transaction will be in the form ofcommitment fee, discount fee and documentation fee.


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Mechanism- a case

Export-Import Bank of India, (EXIM Bank) has started with a

scheme to the Indian exporters by working out an intermediarybetween the exporter and the forfeiter.

The scheme takes place in the following stages:

1. Negotiations being between exporter and importer with regard

to contract price, period of credit, rate of interest, etc.2. Exporter approaches EXIM Bank with all the relevant details

for an indicative discount quote.

3. EXIM Bank approaches an overseas forfeiter, obtain thequote and gets back to exporter with the offer.

4. 4.Exporter and importer finalize the term of contract. All costslevied by a forfeiter are to be transferred to the overseasbuyer. As such discount and other charges are loaded in thebasic contract value.


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Mechanism- a case

5. Exporter approaches EXIM Bank and it in turn the forfeiter

for the firm quote. The exporter confirm the acceptance ofthe arrangement.

6. Export takes place shipping documents along with bill ofexchange, promissory note have to be in the prescribedformat.

7. 7.Importers bank delivers shipping documents to importeragainst acceptance of bill of exchange or on receipt ofpromissory note from the importer as the case may be andsend these to exporters bank with its guarantee.

8. Exporters bank gets bill of exchange/promissory noteendorsed with the words Without Recourse from the

exporter and present the document(s) to EXIM Bank whoin turn send it to the forfeiter.


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Mechanism- a case

9.Forfaiter discounts the documents at the pre-determined rate andpasses on funds to EXIM Bank for onward disbursement toexporters bank Nostro account of exporters bank.

10.Exporters bank credits the amount to the exporter.

11.Forfaiter presents the documents on due date to the importersbank and receives the dues.

12.Exporters bank recovers the amount from the importer.


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DIFFERENCE BETWEENFACTORING AND FORFAITING

1.Suitable for ongoing openaccount sales, not backedby LC or accepted bills orexchange.

2.Usually provides financingfor short-term credit periodof up to 180 days.

1. Oriented towards singletransactions backed by LCor bank guarantee.

2.Financing is usually formedium to long-term creditperiods from 180 days up toseven years though short

term credit of 30180 days isalso available for largetransactions.


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3.Requires a continuousarrangements between factorand client, whereby all salesare routed through the factor.

4. Factor assumesresponsibility for collection,helps client to reduce hisown overheads.

3.Seller need not route orcommit other business to theforfeiter. Deals are concludedtransaction-wise.

4.Forfaiters responsibilityextends to collection offorfeited debt only. Existingfinancing lines remainsunaffected.


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5.Separate charges are appliedfor

financing

collection

administration

credit protection and

provision of information.

5.Single discount charges isapplied which depend on

guaranteeing bank and countryrisk,

credit period involved and

currency of debt.

Only additional charges iscommitment fee, if firmcommitment is required prior todraw down during delivery

period.


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DIFFERENCE BETWEENFACTORING AND FORFAITING6.Service is available for domestic

and export receivables.

7.Financing can be with or withoutrecourse; the credit protectioncollection and administration

services may also be providedwithout financing.

8.Usually no restriction on minimumsize of transactions that can becovered by factoring

9.Factor can assist with completingimport formalities in the buyerscountry and provide ongoingcontract with buyers.

6.Usually available for exportreceivables only denominated inany freely convertible currency.

7.It is always without recourse andessentially a financing product.

8.Transactions should be of aminimum value of USD 250,000.

9.Forfaiting will accept only cleandocumentation in conformity withall regulations in theexporting/importing countries

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