MFSChapter – 6M. Y. KHAN

Factoring and Forfaiting

Factoring: The Concept…

• “Factor is a financial intermediary which assumes the responsibility of collection of receivables arising out of credit sales of their clients and in return charges commission for its services”.

• So, a Factor is…

A Financial Intermediary/Institute/Company That buys invoices of a manufacturer or a trader, at a

discount, and Takes responsibility for collection of payments.

Factoring: The Concept…

• “Factoring is the Sale of Book Debts by a firm

(Client) to a financial institution (Factor) on the

understanding that the Factor will pay for the

Book Debts as and when they are collected or on

a guaranteed payment date. Normally, the

Factor makes a part payment (usually upto 80%)

immediately after the debts are purchased

thereby providing immediate liquidity to the

Client”.

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Factoring Services - Concept

Client Customer

Factor

Order placed

Deliver of goods

Client submits invoice

Factor-Prepayment

Monthly statements

Customer pays

Process of Factoring:

• Client makes a credit sale with a customer.• Client sells the customer’s account to the Factor and notifies

the customer.• Factor makes partly 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.

Charges for Factoring Services:

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

• Commission is charged up-front.

• For making immediate partly 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.

Functions of a Factor:

1. Administration of sales ledger- Maintains the client’s sales ledger- Gives periodic reports- Current status of his receivables- Receipts of payments from customers- Customer-wise record of payments- Change in payment pattern

2. Provision of collection facility- Undertakes to collect receivables on behalf of the client- Relieving the clients from problems involved in collection- Enables the clients to reduce cost of collection

Functions of a Factor: CONT…

3. Financing Trade Debts:

4. Credit Control And Credit Protection:- This service is provided where debts are factored

without recourse. Factor assumes the risk of default.

5. Advisory Services:- Specialized knowledge and experience- Customers’ perception- Change in marketing strategies- Emerging trends

Types / Forms of Factoring:

1. Recourse Factoring: Factor does not assume credit risks associated with

receivables. Credit Risk is borne by the Client. In India, Factoring is done with recourse.

2. Non-Recourse Factoring: Factor assumes credit risks associated with receivables.

Charges a higher commission Credit risk is assumed by Factor In USA/UK, Factoring is commonly done without recourse.

Types / Forms of Factoring:

3. Advance Factoring: Factor pays a specified portion (75% to 90%) in advance.

Balance being paid upon collection from the customer. The client has to pay interest on advance payment.

Example of Advance Factoring Mechanism:

Client

CustomerFactor

1Credit sale

2Assigns invoice

4 monthly statement of accounts

5 payment to factor

Types / Forms of Factoring: CONT…

4. Maturity Factoring / Collection Factoring:

Factor does not make any advance payment to the Client.

Factor Pays on date of collection/agreed future date.

Less RISK for Factor and charges nominal commission.

5. Full Factoring / Old Line Factoring:

Features of almost all the factoring services.

Entire spectrum of services; collection, credit protection, sales

ledger administration, short-term finance.

Types / Forms of Factoring: CONT…

6. Disclosed Factoring:

Name of factor is disclosed in sales invoice.

7. Undisclosed Factoring: Name of factor is NOT disclosed in sales invoice.

8. Domestic Factoring: Buyer, Seller, Factor domiciled in the same country.

Types / Forms of Factoring: CONT…

9. Export / Cross Border / International Factoring:

Usually Four Parties Involved Viz. the Exporter, Importer,

Export Factor, Import Factor.

Two Agreements.

Import Factor Provides Link Between Export Factor and

Importer.

Import factor underwrites customer trade credit risk, collects

receivables and transfers fund to export factor.

International Factoring Transactions:

Exporter

Import Factor

Importer

Export Factor

1

4

2

3

5

6

78

9

10

Receives orderCredit limit request

ApprovalDelivers goods

Submits documentsPrepaymentDocumentsCollection

Payment remittanceBalance payment

International Factoring Transactions

Advantages of Factoring:

1. Off-balance Sheet Finance

2. Reduction of Current Liabilities

3. Improvement in Current Ratio

4. Higher Credit Standing:

5. More time for Planning and Production

6. Reduction of Cost and Expenses

7. Additional Source of Finance

WHY FACTORING HAS NOT BECOME POPULAR IN INDIA?

• Banks’ unwillingness to provide factoring services

• Problems in recovery.

• Factoring requires assignment of debt which attracts Stamp Duty.

• Cost of transaction becomes high.

• Lack of awareness.

Factoring in INDIA: Major Players

• SBI Factors and Commercial Services Pvt. Ltd.• Canbank Factors Limited• Global Trade Finance Limited• Foremost Factors Limited• HSBC Bank• CITI Bank NA, India• Standard Chartered Bank• SIDBI• ECGC Ltd.

FORFAITING: THE CONCEPT

- “Forfeiting refers to financing of receivables pertaining to international trade”.

- 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.

- Converts exporter’s credit sale into cash sale.

- Discounting the documents covering the entire risk of non-payment in collection.

- Credit period can range from 3 to 5 years.

Exporter

Avalling Bank

Importer

Forfaiter

1

2

3

4

5

6 7

8

9

10

1. Committed to purchase debt2. Commercial contact3. Delivery of goods4. Gives guarantee5. Hands over documents

6. Delivers documents7. Makes payment8. Presents document for payment9. Repays at maturity10.Payment to the forfaiter

ForfaitingTransactions

Characteristics of Forfaiting:

• Converts Deferred Payment Exports into cash transactions, providing liquidity and cash flow to Exporter.

• Discharge Exporter from Cross-border Political OR Exchange 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.

Characteristics of Forfaiting: Cont…

• Exporter is freed from credit administration.

• Simple Documentation as finance is available against bills.

• Forfait financer is responsible for each of the Exporter’s trade transactions. Hence, Export business can be done more efficiently.

• Forfait transactions are confidential.

FORFAITER’S CHARGES

• The DISCOUNT charged by the Forfaiter depends upon:

Cost of ForfaitingMargin to cover riskManagement chargesFees for delayed paymentPeriod of Forfaiting contractCredit rating of Avalling BankCountry/Currency Risk of the importer

Export Factoring V/s Forfeiting:

Sr. No.

Export Factoring Forfaiting

1 75 to 90% Financing 100% Financing

2 Financing, Collection, Sales Ledger Administration

Pure Financing

3 Short Term Financing 3 To 5 Years

4 Does not guard against Exchange Rate Fluctuation

Forfaiter guards.

FACTORING vs. FORFAITING

POINTS OF DIFFERENCE

FACTORING FORFAITING

Extent of Finance Usually 75 – 80% of the value of the invoice

100% of Invoice value

Credit Worthiness Factor does the credit rating in case of non-recourse factoring transaction

The Forfaiting Bank relies on the creditability of the Availing Bank

Services provided Day-to-day administration of sales and other allied/advisory services

No services are provided

FACTORING vs. FORFAITING – CONT…POINTS OF

DIFFERENCEFACTORING FORFAITING

Recourse With or without recourse Always without recourse

Size of transaction

Usually no restriction on minimum size of transactions that can be covered by factoring.

Transactions should be of a minimum value of USD 250,000.

Scope of service Service is available for domestic and export receivables.

Usually available for export receivables only denominated in any freely convertible foreign currency.

WHY FORFAITING HAS NOT DEVELOPED…

• Relatively new concept in India.

• High Rupee Fluctuation

• High cost of funds

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

• RBI Guidelines are unclear.

• Very few institutions offer such services in India. Exim Bank is one of the major player and very few other co’s involved.

• Lack of awareness.

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List of some Forfaiters:

• Standard Bank, London

• Hong Kong Bank

• ABN AMRO Bank

• Meghraj Financial Services

• Triumph International Finance India Ltd.,

• Natwest Bank

• Meridian Finance Group