Factoring Forfaiting Theory

8/12/2019 Factoring Forfaiting Theory

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhINTRODUCTION

Factoringis a financial transaction whereby abusiness sells its accounts receivable

(i.e., invoices) to a third party (called a factor) ata discount in exchange for immediate moneywith which to finance continued business.


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AMITY GLOBAL

BUSINESS SCHOOL Chandigarh

Factoring means an arrangement between afactor and his client which includes at leasttwo of the following services to be providedby the factor-

1)Finance2)Maintenance of accounts

3)Collection of debts

4)Protection against credit risk


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhFactoring Services - Concept

Definition:

Factoring is defined as acontinuing legalrelationship between a financial institution

(the factor) and a business concern (theclient), selling goods or providing servicesto trade customers (the customers) onopen account basis whereby the Factorpurchases the clients book debts(accounts receivables) either with orwithout recourse to the client and inrelation thereto controls the creditextended to customers and administersthe sales ledgers. 3


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhFactoring functions..

It is purchasing & collection theclients a/cs receivables (with orwithout recourse),

Sales Ledger management Credit investigation & undertaking of

risks

Provision of finance against debts Rendering consultancy services

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhFactoring Services - Concept

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Client Customer

Factor

Order placed

Deliver of goods

Client submits invoice

Factor-Prepayment

Monthly statements

Customer pays


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhWHY A FIRM USE

FACTORING

Factoring is used by a firm when the available Cash

Balance held by the firm is insufficient to meet

current obligations and accommodate its other cash

needs, such as new orders or contracts.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhSERVICES OFFERED BY A

FACTORa) Follow-up and collection of Receivables from

Clients.

b) Purchase of Receivables with or without recourse.

c) Help in getting information and credit line oncustomers (credit protection)

d) Sorting out disputes , due to his relationship withBuyer & Seller.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhPROCESS INVOLVED IN

FACTORINGa) Client concludes a credit sale with a customer.

b) Client sells the customers account to the Factor andnotifies the customer.

c) Factor makes part payment (advance) against accountpurchased, after adjusting for commission and intereston the advance.

d) Factor maintains the customers account and follows upfor payment.

e) Customer remits the amount due to the Factor.

f) Factor makes the final payment to the Client when theaccount is collected or on the guaranteed payment date.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhMECHANICS OF FACTORING

a) The Client (Seller) sells goods to the buyer and preparesinvoice with a notation that debt due on account of thisinvoice is assigned to and must be paid to the Factor(Financial Intermediary).

b) The Client (Seller) submits invoice copy only with DeliveryChallan showing receipt of goods by buyer, to the Factor.

c) The Factor, after scrutiny of these papers, allows payment(,usually up to 80% of invoice value). The balance isretained as Retention Money (Margin Money). This is alsocalled Factor Reserve.


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a) The drawing limit is adjusted on a continuous basis after

taking into account the collection of Factored Debts.

b) Once the invoice is honored by the buyer on due date, theRetention Money credited to the Clients Account.

c) Till the payment of bills, the Factor follows up the payment

and sends regular statements to the Client.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhCHARGES FOR FACTORING

SERVICESa) Factor charges Commission (as a flat percentage of value of

Debts purchased) (0. 5 0% to 1. 5 0%)

b) Commission is collected up-front.

c) For making immediate part payment, interest charged. Interest

is higher than rate of interest charged on Working Capital

Finance by Banks.

d) If interest is charged up-front, it is called discount.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhTYPES OF FACTORING

a) Recourse Factoring.

b) Non-recourse Factoring.

c) Maturity Factoring.

d) Cross-border Factoring.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhRECOURSE FACTORING

a) Up to 75 % to 85 % of the Invoice Receivable isfactored.

b) Interest is charged from the date of advance to the date

of collection.c) Factor purchases Receivables on the condition that lossarising on account of non-recovery will be borne by theClient.

d) Credit Risk is with the Client.

e) Factor does not participate in the credit sanctionprocess.

f) In India, factoring is done with recourse.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhNON-RECOURSE FACTORING

a) Factor purchases Receivables on the condition that the Factor hasno recourse to the Client, if the debt turns out to be non-recoverable.

b) Credit risk is with the Factor.

c) Higher commission is charged.

d) Factor participates in credit sanction process and approves creditlimit given by the Client to the Customer.

e) In USA/UK, factoring is commonly done without recourse.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhMATURITY FACTORING

a) Factor does not make any advance payment to the Client.

b) Pays on guaranteed payment date or on collection of

Receivables.

c) Guaranteed payment date is usually fixed taking intoaccount previous collection experience of the Client.

d) Nominal Commission is charged.

e) No risk to Factor.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhCROSS - BORDER FACTORING

a) It is similar to domestic factoring except that there arefour parties, viz.,

b) a) Exporter,

c) b) Export Factor,

d) c) Import Factor, and

e) d) Importer.

f) It is also called two-factor system of factoring.

g) Exporter (Client) enters into factoring arrangement withExport Factor in his country and assigns to him exportreceivables.


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AMITY GLOBAL

BUSINESS SCHOOL Chandigarhexport Factor enters into arrangement with

Import Factor and has arrangement for creditevaluation & collection of payment for an agreed fee.

Notation is made on the invoice that importer has to

make payment to the Import Factor.Import Factor collects payment and remits to Export

Factor who passes on the proceeds to the Exporter afteradjusting his advance, if any.

Where foreign currency is involved, Factor coversexchange risk also.


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Advantages of Factoring

Factoring provides a large and quick boost to

cashflow.

there are many factoring companies, so prices

are usually competitive it can be a cost-effective way of outsourcing your

sales ledger while freeing up your time to

manage the business

it assists smoother cashflow and financial

planning

some customers may respect factors and pay

more quickly 18


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factors may give you useful information about

the credit standing of your customers and theycan help you to negotiate better terms with your

suppliers

factors can prove an excellent strategic - as well

as financial - resource when planning business

growth

you will be protected from bad debts if you

choose non-recourse factoring - see the page inthis guide on recourse factoring and non-

recourse factoring

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http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073791095&type=RESOURCES


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cash is released as soon as orders are invoiced

and is available for capital investment and

funding of your next orders

factors will credit check your customers and canhelp your business trade with better quality

customers and improved debtor spread

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Demerits of Factoring The cost will mean a reduction in your profit

margin on each order or service fulfilment.

It may reduce the scope for other borrowing -

book debts will not be available as security. Factors will restrict funding against poor quality

debtors or poor debtor spread, so you will need

to manage these funding fluctuations.

It may be difficult to end an arrangement with a

factor as you will have to pay off any money they

have advanced you on invoices if the customer

has not paid them yet. 21


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Some customers may prefer to deal directly with

you.

How the factor deals with your customers will

affect what your customers think of you. Makesure you use a reputable company that will not

damage your reputation.

You have to pay extra to remove your liability forbad debtors.

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhFACTORING IN INDIA

a) Kalyana Sundaram Committee recommendedintroduction of factoring in 1989.

b) Banking Regulation Act, 1949, was amended in 1991 forBanks setting up factoring services.

c) SBI/ Canara Bank have set up their FactoringSubsidiaries:-

d) SBI Factors Ltd., (April, 1991) ( an asset base of Rs1908.00 corers as on March 31, 2008, highest in India)

e) Canara Bank Factors Ltd., (August, 1991).f) RBI has permitted Banks to undertake factoring services

through subsidiaries.


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhWhy we need Factoring?

For Smooth cash flow

For meeting working capital needs

Overcome the situation from high cost

of capital and reduced profit

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhForfaiting..

It is a highly flexible technique that allows an Exporter

to grant attractive credit terms to foreign Buyers,

without tying up cash flow or assuming the risks of

possible late payment or default. Simultaneously, the

Exporter is fully protected against interest and/or

currency rates moving unfavourably during the credit

period

Forfaiting is a highly effective sales tool, whichsimultaneously improves cash-flow and eliminates

risk.

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhSix Parties in Forfaiting

1. Exporter (India)

2. Importer (Abroad)

3. Exporters Bank (India)

4. Importers/Avalising Bank (Abroad)

5. EXIM Bank (India )

6. Forfaiter (Abroad)

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhMechanism

1. The exporter and importer negotiate theproposed export sale contract. Then the

exporter approaches the forfaiter to ascertain

the terms of forfaiting.

2. The forfaiter collects details about theimporter, supply and credit terms,

documentation etc.

3. Forfaiter ascertains the country risk and creditrisk involved.

.

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4. The forfaiter quotes the discount rate.

5. The exporter then quotes a contract price to theoverseas buyer by loading the discount rate,

commitment fee etc. on the sale price of the

goods to be exported.

6. The exporter and forfaiter sign a contract.

7. Export takes place against documents

guaranteed by the importers bank.

8. The exporter discounts the bill with the forfaiter

and the latter presents the same to the importer

for payment on due date or even sell it in

secondary market. 29


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Costs of forfaitingThe forfaiting transaction has typically three costelements:

1. Commitment fee, payable by the exporter to

the forfaiter for latters commitment to execute aspecific forfaiting transaction at a firm discount

rate with in a specified time.

2. Discount fee, interest payable by the exporter

for the entire period of credit involved anddeducted by the forfaiter from the amount paid to

the exporter against the availised promissory

notes or bills of exchange.

3. Documentation fee.30


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Benefits of forfaiting1. It frees the exporter from political or

commercial risks from abroad.

2. Forfaiting offers without recourse finance toan exporter. It does not effect the exporters

borrowing limits/capacity.

3. Forfaiting relieves the exporter from

botheration of credit administration and

collection problems.


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4. Forfeiting is specific to a transaction. It does

not require long term banking relationship with

forfeiter.

5. Exporter saves money on insurance costs

because forfeiting eliminates the need for export

credit insurance.

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhBenefits to Exporters

Converts a Deferred Paymentexport into a

cash transaction, improves liquidity

Frees Exporter from cross-border political or

commercial risks associated

Finances upto 100 percentof export value

It is a Without Recourse finance

Hedges against Interest and Exchange Risks

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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhFACTORING vs. FORFAITING

POINTS OFDIFFERENCE

FACTORING FORFAITING

Extent of Finance Usually 75 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 administrationof sales and other alliedservices

No services areprovided

Recourse With or without recourse Always withoutrecourse

Sales By Turnover By Bills


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhDIFFERENCE BETWEEN

FACTORING AND FORFAITING1.Suitable for ongoing open

account sales, not backed

by LC or accepted bills or

exchange.

2. Usually provides financingfor short-term credit period

of upto 180 days.

1. Oriented towards single

transactions backed by LC

or bank guarantee.

2. Financing is usually for

medium to long-term creditperiods from 180 days upto

7 years though shorterm

credit of 30180 days is

also available for large

transactions.

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FACTORING AND FORFAITING3.Requires a continuous

arrangements betweenfactor and client, wherebyall sales are routed throughthe factor.

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

3. Seller need not route orcommit other business tothe forfaiter. Deals areconcluded transaction-wise.

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

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FACTORING AND FORFAITING5. Separate charges are

applied for

financing

collection

administration

credit protection and provision of information.

5. Single discount charges isapplied which depend on

guaranteeing bank andcountry risk,

credit period involved

and currency of debt.

Only additional charges iscommitment fee, if firmcommitment is requiredprior to draw down duringdelivery period.

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A G O A


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FACTORING AND FORFAITING6. Service is available for

domestic and exportreceivables.

7. Financing can be with

or without recourse; thecredit protectioncollection andadministration services

may also be providedwithout financing.

6. Usually available forexport receivables onlydenominated in anyfreely convertible

currency.7. It is always without

recourse andessentially a financing

product.

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AMITY GLOBAL


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AMITY GLOBAL

BUSINESS SCHOOL ChandigarhList of some Forfaiters

Standard Bank, London Hong Kong Bank

Indo Aval

ABN AMRO Bank

Meghraj Financial Services

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Factoring Forfaiting Theory

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