DISCOUNTING, FACTORING & FORFAITINGASSIGNED BY- DR.PREMRAJ ALVA

ROLL NO NAMES TOPIC

101 PRAGATI KEDAR Comparative Analysis, Drawbacks & Case study- Forfaiting

102 VARAD DALVI Introduction, Mechanics & Essential- Forfaiting

104 OMKAR PILWALKAR Different types of Bill Discounting & Case Study- Discounting

105 DHRUTI BHAGAT Introduction, Definition, Bill Discounting & Conditions- Discounting

106 PRAFUL OJHA Types, Statutes, Why Factoring is not popular in India, Case Study-Factoring

107 MOHIT SINGH Types , Domestic, International & Services- Factoring

108 RAJ BAHADUR SINGH Characteristics, Costs & Why- Forfaiting

109 VIDHU SIVASANKARAN Introduction, Definition, What & Why- Factoring

110 POOJA PAWAR Process, Mechanics & Charges- Factoring

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INTRODUCTION A process that Accounts from Time preferences.

Converts Future Values to Present Values.

PRESENT VALUE

FUTURE VALUE

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DEFINITION OF DISCOUNTING The process of converting values expressed in dollars

received at a point in time to an equivalent value expresses in dollars received at an earlier point in time.

Compounding is the reverse process.

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BILL DISCOUNTING While discounting a bill, the Bank buys the bill (i.e. Bill of

Exchange or Promissory Note) before it is due and credits the value of the bill after a discount charge to the customer's account.

The transaction is practically an advance against the security of the bill and the discount represents the interest on the advance from the date of purchase of the bill until it is due for payment.

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CONDITIONS A bill must be a usance bill.

It must have been accepted and bears at least two good signatures (e.g. of reputable individuals, companies or banks etc.)

The Bank will normally only discount trade bills.

Where a usance bill is drawn at a fixed period after sight the bill must be accepted to establish the maturity.

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CONDITIONS The discount should be based on real trade background.

The discount tenor starts from the date of discount and expires at the maturity of the bill.

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DIFFERENT TYPES OF BILL DISCOUNTING

Sales bill discounting (Drawer bill discounting).

Supplier bill discounting (Drawee bill discounting).

LC Bill discounting.

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INVOICE DISCOUNTING – CASE STUDY

I have owned and operated a profitable business for the past 10 years manufacturing and supplying Prescription lenses and frames to opticians throughout the UK.

During the so called credit crunch, I was annoyed and frustrated by my bank trying continually to Scale back the limit on my business overdraft without any valid reason given.

For example, the Account limit in 2007 was £150,000 but this year I was advised that it had been arbitrarily reduced To £100,000 which immediately put a stop to my new product development and expansion plans.

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My Accountants, who are a large national firm, directed me to Murray & Co in London who suggested That the overdraft could be substituted by an Invoice Discounting facility.

At first I was not convinced Of the benefits but now after a few months they are very clear.

I am able to borrow up to 90% of my outstanding invoices at any time which allows me access of up to £250,000 in working capital.

This limit will be extended and increased in line with my business Expansion plans which are progressing well.

Not only did invoice discounting generated more capital

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But also by switching Lenders my own bank had no choice but to release a second charge on my

House because the overdraft no longer existed.

Obviously, that gave my wife and I the comfort of

Knowing that our home was safe in the event of any future financial problems.

In fact, the only Security held by my new funder is the value of the outstanding invoices.

JB – Northwest

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INTRODUCTION Came into existence in the year 1920

It was not an organised sector that time

Association of British Factors(ABF) came in 1976

Nearly 90% of global factoring turnover comes from USA & European countries

RBI appointed the C.S.Kalyanasundaram Committee (1988)

It suggested to start factoring by a bank through its subsidiary

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DEFINITION OF FACTORING Robert W. Johnson in his book ‘Financial Management’

states, “factoring is a services involving the purchase by a financial organisation, called a factor, of receivables owned to manufacturers and distributors by their customers, with the factor assuming full credit and collection responsibilities.

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WHAT IS FACTORING? Factoring is an ongoing arrangement between the client and

the factor, where the sales of goods and services are made on open account terms and the invoices for the same are assigned to the factor regularly for the purpose of funding, collection and sales ledger administration.

Factoring involves a long-term relationship between the buyer and the seller with the whole turnover being assigned to the factoring company.

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WHY USE FACTORING? Through the use of Factoring receivables are instantly

converted into cash leading to improved cash flows that can help funding of future growth.

It facilitate an efficient follow up of payments from buyers, which is made possible through relationships developed by factors with client’s buyers.

Factoring provides credit protection for export sales which enables to do business with buyers who are unwilling to open Letters of Credit.

Factoring also provides other peripheral services such as advisory services, credit assessment, etc.

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WHAT ARE THE TYPES OF FACTORING ARRANGEMENT?

There are basically two types of Factoring arrangements:

1) Domestic Factoring- If you are selling in India.

2) International Export Factoring- If you are exporting from India.

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DOMESTIC FACTORING The factoring arrangement where all the three- the factor,

the seller and the buyer are in the same country, subject to the same laws.

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INTERNATIONAL FACTORING The factoring arrangement, where the seller and the buyer

are in two different countries involving co-operation between two factoring companies, one in the seller’s country (Export Factor) and the other in the buyer’s country (Import Factor)

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SERVICES OFFERED BY FACTOR Follow-up and collection of Receivables from Clients.

Purchase of Receivables with or without recourse.

Help in getting information and credit line on customers (credit protection)

Sorting out disputes, if any, due to his relationship with Buyer & Seller.

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PROCESS INVOLVED IN FACTORING

Client concludes a credit sale with a customer.

Client sells the customer’s account to the Factor and notifies the customer.

Factor makes part payment (advance) against account purchased, after adjusting for commission and interest on the advance.

Factor maintains the customer’s account and follows up for payment.

Customer remits the amount due to the Factor.

Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date.

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MECHANICS OF FACTORING The Client (Seller) sells goods to the buyer and prepares invoice

with a notation that debt due on account of this invoice is assigned to and must be paid to the Factor (Financial Intermediary).

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

The Factor, after scrutiny of these papers, allows payment (,usually upto 80% of invoice value). The balance is retained as Retention Money (Margin Money). This is also called Factor Reserve.

The drawing limit is adjusted on a continuous basis after taking into account the collection of Factored Debts.

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Once the invoice is honoured by the buyer on due date, the Retention Money credited to the Client’s Account.

Till the payment of bills, the Factor follows up the payment and sends regular statements to the Client.

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CHARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to 1.50%).

Commission is collected up-front.

For making immediate part payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks.

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

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TYPES OF FACTORING Recourse Factoring

Non-recourse Factoring

Maturity Factoring

Cross-border Factoring

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RECOURSE FACTORING Up to 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.

In India, factoring is done with recourse.29

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.

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

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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.

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CROSS BRODER 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.

Exporter (Client) enters into factoring arrangement with Export Factor in his country and assigns to him export receivables.

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Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & 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 after adjusting his advance, if any.

Where foreign currency is involved, Factor covers exchange risk also.

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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.

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WHY FACTORING HAS NOT BECOMING POPULAR IN INDIA

Banks’ reluctance to provide factoring services.

Bank’s resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per RBI Guidelines).

Problems in recovery.

Factoring requires assignment of debt which attracts Stamp Duty.

Cost of transaction becomes high.

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TURKISH RUGS MANUFACTURERS PREFER INTERNATIONAL FACTORING – CASE

STUDY

Thanks to factoring, Step Carpet could grow their Exports significantly.

Step Halıcılık ve Mağazacılık San ve Tic A.S. is a well-known brand of contemporary rugs with boutiques in London, Paris, Milan, Istanbul, New York, Dubai and many other design capitals of the world.

Step Carpet focuses on the design and manufacturing of modern, fashionable rugs and home accessories. Combining traditional rug-making techniques with new technology.

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Step is known as a pioneer in the interior design business with innovative collections inspired by the latest fashion, colors and textures.

Step Carpet’s strategy is to expand their business to further European markets. TEB Factoring as Export Factor was recommended and introduced by one of their clients, an A.S, to Step Carpet, which shares the production facility with them.

New debtors from Germany and the Czech Republic were requiring longer open account terms in place of L/C’s. After a positive assessment, TEB Factoring was able to offer a full notification export factoring facility to Step Carpet.

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In 2012, Step Carpet decided to sign an export factoring agreement with TEB to utilize their international factoring services, which includes the following benefits:

1. 100 % credit protection against customer insolvency default backed by FCI Import Factors.

2. Outsourcing of the receivables ledger bookkeeping workload and local collection services provided by Import Factors abroad.

3. Short-term advances against the factored accounts receivable provided by TEB Factoring.

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Since then, thanks to the excellent service provided by TEB Factoring and its Import Factor correspondents, Euro factor AG in Germany and Factoring KB in the Czech Republic, Step Carpet has successfully exploited new markets, increased their export business, and solidified their supplier relationships. For Step, international factoring has been a useful financial tool which will enable them to generate an additional projected turnover of EUR10 million in 2013.

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INTRODUCTION “Forfait” is derived from French word ‘A Forfait’ which

means surrender of fights.

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.

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Exporter under Forfaiting surrenders his right for claiming payment for services rendered or goods supplied to Importer in favor of Forfaiter.

Bank (Forfaiter) assumes default risk possessed by the Importer.

Credit Sale gets converted as Cash Sale.

Forfaiting is arrangement without recourse to the Exporter (seller)

Operated on fixed rate basis (discount)

Finance available up to 100% of value (unlike in Factoring)

Introduced in the country in 1992.43

MECHNAICS OF FORFAITING

EXPORTER IMPORTER

FORFAITER AVALLING BANK

HELD TILL MATURITY

SELL TO GROUPS OF INVESTORS

TRADE IN SECONDARY MARKET44

ESSENTIAL REQUISITES OF FORFAITING TRANSACTION

Exporter to extend credit to Customers for periods above 6 months.

Exporter to raise Bill of Exchange covering deferred receivables from 6 months to 5 years.

Repayment of debts will have to be availed or guaranteed by another Bank, unless the Exporter is a Government Agency or a Multi National Company.

Co-acceptance acts as the yard stick for the Forfeiter to credit quality and marketability of instruments accepted.

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Promissory notes are sent for availing to the Importer’s Bank.

Availed notes are returned to the Importer.Availed notes sent to Exporter.Availed notes sold at a discount to a Forfaiter on a NON-

RECOURSE basis.Exporter obtains finance.Forfaiter holds the notes till maturity or securities these

notes and sells the Short Term Paper either to a group of investors or to investors at large in the secondary market.

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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.

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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.

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COSTS INVOLVED IN FORFAITING Commitment Fee:- Payable to Forfaiter by Exporter in

consideration of forfeiting 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.

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WHY FORFAITING IS NOT DEVELOPED

Relatively new concept in India.

Depreciating Rupee

No ECGC Cover

High cost of funds

High minimum cost of transactions (USD 250,000/-)

RBI Guidelines are vague.

Very few institutions offer the services in India. EXIM Bank alone does.

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Long term advances are not favoured by Banks as hedging becomes difficult.

Lack of awareness.

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COMPARATIVE ANALYSIS

BILLS DISCOUNTED

FACTORING FORFAITING

1. Scrutiny Individual Sale Transaction

Service of Sale Transaction

Individual Sale Transaction

2. Extent of Finance

Upto 75 – 80% Upto 80-20% Upto 100%

3. Recourse With Recourse With or Without Recourse

Without Recourse

4. Sales Administration

Not Done Done Not Done

5. Term Short Term Short Term Medium Term

6. Charge Creation

Hypothecation Assignment Assignment52

DRAWBACKS NON AVAILABILITY FOR SHORT & LONG PERIODS.

NON AVAILABILITY FOR FINANCIALLY WEAK COUNTRIES.

DOMINANCE OF WESTERN CURRENCIES.

DIFFICULTY IN PROCURING INTERNATIONAL BANK’S GUARANTEE.

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MECHANISM – A CASE STUDY OF FORFAITING

Export-Import Bank of India, (EXIM Bank) has started with a scheme to the Indian exporters by working out an intermediary between 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 the quote and gets back to exporter with the offer.

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MECHANISM- A CASE STUDY4.Exporter and importer finalize the term of contract. All costs levied

by a forfeiter are to be transferred to the overseas buyer. As such discount and other charges are loaded in the basic contract value.

5. Exporter approaches EXIM Bank and it in turn the forfeiter for the firm quote. The exporter confirm the acceptance of the arrangement.

6. Export takes place — shipping documents along with bill of exchange, promissory note have to be in the prescribed format.

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MECHANISM- A CASE STUDY7. Importer’s bank delivers shipping documents to importer against

acceptance of bill of exchange or on receipt of promissory note from the importer as the case may be and send these to exporter’s bank with its guarantee.

8. Exporter’s bank gets bill of exchange/promissory note endorsed with the words ‘Without Recourse’ from the exporter and present the document(s) to EXIM Bank who in turn send it to the forfaiter.

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MECHANISM- A CASE STUDY9. Forfaiter discounts the documents at the pre-determined rate and

passes on funds to EXIM Bank for onward disbursement to exporter’s bank nostro account of exporter’s bank.

10.Exporter’s bank credits the amount to the exporter.

11.Forfaiter presents the documents on due date to the importer’s bank and receives the dues.

12.Exporter’s bank recovers the amount from the importer.

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THANK YOU

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