FACTORING AND FORFAITING

FactoringLatin Word- ‘facere’Originated –USA,UK and France to

assits firmsA relationship created by an agreement

between the seller of goods/service and the financial institution(factor).

Receivables arising out of sale of goods/service are sold by firm.And the said receivables is passes on to factor.And factor become responsible –sale accounting,credit control and debt collection

Parties of Factoring

Buyer of the goodsSellerFactor i.e. financial institution

SELLING FIRM FACTOR CUSTOMERS RECEIVABLES

AGREEMENT(1)

SALEOF GOODS(2)

INVOICE COPY(3)

ADVANCE PAYMENT/DISCOUNTING (4)

FINAL PAYMENT AFTER DEDUCTING FEES AND CHARGES,IF ANY(5)

PAYMENTS

Steps involved in factoring transaction

Types of Factoring

A. Recourse and Non-recourse Factoring

B. Advance and Maturity FactoringC. Conventional or Full factoring

• Collection of receivables• Maintenance of sales ledger• Credit collection• Credit control• Credit Insurance• Credit risk

D. Domestic and Export factoringE. Limited Factoring

Types of Factoring (Cont…)

F. Selected Seller Based FactoringG. Selected Buyer Based FactoringH. Disclosed and Undisclosed

Factoring

Functions of a Factor

Administration of sellers sales ledger

Collection of receivables purchasedProvision of financeProtection against riskAdvisory services-

Customer’s perception for client productsMarketing strategies, emerging trendsSuggests improvements-invoicing, delivery and sales returnHelping for raising finance from financial institutions

ADVANTAGES

Cost savings Liquidity Credit discipline Efficient production Cash flow Better purchasing planning Avoid bad debt Boosting the efficiency ratio

Limitations of factoring

No insurance available for creditDifficult for factor to collect

money due, if buyer and seller are in different area

Lack of professionalism ,competence, underdeveloped expertise, resistance to change

Limited funds – supplierLack of proper credit information

Factoring cost

Commission Charge for collection Sale ledger administration Credit control Collection of debt Providing protection against bad debt

Interest Charge

Factoring in IndiaFactoring and forfaiting , was set up

by RBI in 1988, under the recommendations of the Kalyansundaram committee

RBI guidelines:Prior approvalSubsidiariesExclusive businessReporting

Major factoring firms1. SBI FACS - First factoring company in

1991(SBI,SIDBI,UBI)2. Canback factors-Canara Bank, Andhra bank

and small industrial development bank(60:20:20)

3. Foremost Factors- 1st private sectorNew entrants areI. ICICIII. HSBCIII. Global Trade finance(international factoring,

domestic factoring and forfaiting services)IV. Export Factoring(ECGC)

Sl.No

Characteristic Factoring Bills Discounting

1 Recourse May be with or without recourse

Only with recourse

2 Collector Factor is a collector of receivables

Drawer is the collector of receivables

3 Services Besides financing facility,many other services are also extended

Only financing facility is available

4. Refinancing Receivables once factored cannot be refactored

Bills once discounted can be rediscounted

5 Bulk finance Financing arrangement covers entire quantum of receivables

Financing is bill based

6 Mode of accounting It is off balance sheet financing

No such possibility

FORFAITINGFrench term - forfaitA form of financing of receivables

arising from international trade.A bank/financial institution undertakes

the purchase of trade bills/promissory notes without recourse to the seller

All risk become full responsibility of forfaiter

Forfaiter pays cash to seller after discounting the bills/notes

Parties to forfaiting

ExporterImporterExporter’s bankImporter’s bankThe forfaiter

Modus Operandi

1. Commercial contract2. Transaction3. Notes acceptance4. Factoring contract5. Sale of notes6. Payment

Advantages of forfaitingEliminates RiskImproves Cash FlowsFast, tailor-made financing solutionsCommitments can be issued within

hours/days depending on details.No restrictions on origin of export.Relieves the exporter from

administration and collection problems.Exporter saves money on insurance

costs

Limitations

It is generally not available for short-term financing.

The exporter is responsible for obtaining a bank guarantee for the buyer.

The exporter is responsible for the quality/condition of goods, timeliness of delivery, overshipment, and contract disputes.

Because of the required bank guarantee, the importer's bank line of credit is reduced by a corresponding amount.

Interest costs and commitment fees may be high.

Transaction size is usually limited to $250,000 or more.

Difference in factoring and forfaiting Factoring refers to domestic

bill purchase and discount A factor finances 75-85% of

the account receivables and retains the balance as a reserve till the actual payment is made on the date of maturity

It may be with or without recourse.

Short term transactions involving credit period of upto 180 days are handled

It is a continuous arrangement.

Forfaiting refers to discounting of foreign credit bill in respect of international trade.

A forfaiter discounts the entire value of the bill.

It is a pure financial arrangement and its always without recourse

Financing for medium to long-term credit periods is provided but short term credit (30-180 days) facilities are also made available

Deals are concluded transaction-wise

Responsibility for collection is accepted by factor

Charges are applied for financing, collection, sales adminis, credit protection, provision of information

No restriction on minimum size of transaction

Contract is between seller and factor

Besides financing,a factor also provides other services such as ledger administration etc.

Collection of forfaited debt only.

Single discount charge is made depending on: Guaranteeing bank and country risk, credit period involved, current of debt and additional charges made during delivery period.

Minimum value of USD$ 250.00 per transaction

Contract between exporter and forfeiter

It is a pure financing arrangement