Financial Services 6

8/3/2019 Financial Services 6

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AJITAV ACHARYA



Receivables constitute a significant portion of current assets of a firm. But, for investment in receivables, a firm has to incur certain costs

such as costs of financing receivables and costs of collection fromreceivables.

Further, there is a risk of bad debts also. It is, therefore, very essential to have a proper control and

management of receivables. In fact, maintaining of receivables poses two types of problems; (i)

the problem of raising funds to finance the receivables, and (ii) the

problems relating to collection, delays and defaults of thereceivables.

A small firm may handle the problem of receivables management of its own, but it may not be possible for a large firm to do so efficiently.

In such a case, a firm may avail the services of specialized institutions

engaged in receivables management, called factoring firms.



SBI established, in 1991, a subsidiary- SBIFactors Limited with an authorized capital of

Rs. 25 crores to undertake factoring servicescovering the western zone.



Factoring may broadly be defined as therelationship, created by an agreement,

between the seller of goods/services and afinancial institution called, the factor,whereby the later purchases the receivablesof the former and also controls andadministers the receivables of the former.



“factoring means an arrangement between a factor and hisclient which includes at least two of the following services tobe provided by the factor;

(i) finance, (ii) maintenance of accounts,

(iii) collection of debts and

(iv) protection against credit risk”



1. The buyer of the goods.2. The seller of the goods

3. The factor i.e. financial institution.

The three parties interact with each otherduring the purchase/sale of goods.

The possible procedure that may be followedis summarised below.



The buyer enters into an agreement with theseller and negotiates the terms and conditionsfor the purchase of goods on credit.

He takes the delivery of goods along with theinvoice bill and instructions from the seller tomake payment to the factor on due date.

Buyer will make the payment to the factor intime or ask for extension of time.

In case of default in payment on due date, hefaces legal action at the hands of factor.



The seller enters into contract for the sale of goods oncredit as per the purchase order sent by the buyerstating various terms and conditions.

Sells goods to the buyer as per the contract. Sends copies of invoice, delivery challan along with

the goods to the buyer and gives instructions to thebuyer to make payment on due date.

The seller sells the receivables received from thebuyer to a factor and receives 80% or more paymentin advance.

The seller receives the balance payment from thefactor after paying the service charges.



The factor enters into an agreement with theseller for rendering factor services i.e.

collection of receivables/debts. The factor pays 80% or more of the amount

of receivables copies of sale documents. The factor receives payments from the buyer

on due dates and pays the balance money tothe seller after deducting the service charges.



1. Administrative charges /factoring fees: This charge is usually some percent of the projected sales

turnover of the client for the next twelve months. It variesbetween 1 to 2.5 percent of the projected turnover.

The quantum of charged depends upon the followingfactors.

a) Type of industryb) Financial strength of the client as well as of the debtorsc) Volume of sales

d) Average invoice valuee) Required profit margin to the factorf) Extent of competition



This is levied towards providing instant creditto the client by way of prepayment.

This is normally linked with the base rate of the bank from which the factoring institutionis borrowing money, say, 1 to 2.5 percentabove the said rate.



1. Recourse and Non-recourse Factoring2. Advance and Maturity Factoring

3. Conventional or Full Factoring4. Domestic and Export Factoring5. Limited Factoring6. Disclosed and Undisclosed Factoring



In Recourse factoring arrangement, the

factor provides all types of facilities except

debt protection. In other words, the client is responsible for

any bad debts incurred. It is popular in developing countries.



In case of non-recourse factoring, the risk or losson account of non-payment by the customers of the client is to be borne by the factor and he

cannot claim this amount from the selling firm. Since the factor bears the risk of non-payment,

commission or fees charged for the services incase of nonrecourse factoring is higher thanunder the recourse factoring.

The additional fee charged by the factor forbearing the risk of bad debts/non-payment onmaturity is called del credere commission.



Under advance factoring arrangement, thefactor pays only a certain percentage (between75 % to 90 %) of the receivables in advance to

the client, the balance being paid on theguaranteed payment date.

As soon as factored receivables are approved,the advance amount is made available to the

client by the factor. The factor charges discount/interest on the

advance payment.



In case of maturity factoring, no advance ispaid to client and the payment is made to the

client only on collection of receivables or theguaranteed payment data as the case may beagreed between the parties.

Thus, maturity factoring consists of the saleof accounts receivables to a factor with nopayment of advance funds at the time of sale.



It is also known as Old Line Factoring. Under this system the factor performs almost

all services of collection of receivables,maintenance of sales ledger, credit collection.

The factor also takes the corresponding riskof default or credit risk and the factor will

have claims on the debtor as also the clientcreditor. It includes all features of non-recourse and

advance factoring.



The basic difference between the domesticand export factoring is on account of the

number of parties involved. In the domestic factoring three parties are

involved, namely:I. Customer (buyer)II. Client (seller)III. Factor (financial intermediary)



All the three parties reside in the same country. Export factoring is also termed as cross-

border/international factoring and is almost similar todomestic factoring except that there are four parties to

the factoring transaction. Namely, the exporter (selling firm or client), the importer

or the customer, the export factor and the import factor. since, two factors are involved in the export factoring, it is

also called two-factor system of factoring.

Two factor system results in two separate but inter-relatedcontracts:1. between the exporter (client) and the export factor.2. export factor and import factor.



Under limited factoring, the factor discountsonly certain invoices on selective basis and

converts credit bills into cash in respect of those bills only.



In disclosed factoring, the name of the factoris mentioned in the invoice by the supplier

telling the buyer to make payment to thefactor on due date. However, the supplier may continue to bear

the risk of bad debts (i.e. non-payments)without passing to the factor.

The factor assumes the risk only undernonrecourse factoring agreements.



Under undisclosed factoring, the name of thefactor is not disclosed in the invoice.

But still the control lies with the factor. The factor maintain sales ledger of the seller

of goods, provides short-term finance againstthe sales invoices but the entire transactionstake place in the name of the suppliercompany (seller).

Financial Services 6

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