FACTORING
MEANING OF FACTORING
Factoring is a financial service in which the business entity sells its bill receivables to a third
party at a discount in order to raise funds. It differs from invoice discounting. The concept of
invoice discounting involves, getting the invoice discounted at a certain rate to get the funds,
whereas the concept of factoring is broader. Factoring involves the selling of all the accounts
receivable to an outside agency. Such an agency is called a factor.
CONCEPT OF FACTORING
The seller makes the sale of goods or services and generates invoices for the same. The business
then sells all its invoices to a third party called the factor. The factor pays the seller, after
deducting some discount on the invoice value. The rate of discount in factoring ranges from 2 to
6 percent. However, the factor does not make the payment of all invoices immediately to the
seller. Rather, it pays only up to 75 to 80 percent of the invoice value after deducting the
discount. The remaining 20 to 25 percent of the invoice value is paid after the factor receives the
payments from the seller’s customers. It is called factor reserve.
SALIENT FEATURES OF FACTORING:
(i) Credit Cover:
The factor takes over the risk burden of the client and thereby the client’s credit is covered
through advances.
(ii) Case advances:
The factor makes cash advances to the client within 24 hours of receiving the documents.
(iii) Sales ledgering:
As many documents are exchanged, all details pertaining to the transaction are automatically
computerized and stored.
(iv) Collection Service:
The factor, buys the receivables from the client, they become the factor’s debts and the collection
of cheques and other follow-up procedures are done by the factor in its own interest.
(v)Provide Valuable advice:
The factors also provide valuable advice on country-wise and customer-wise risks. This is
because the factor is in a position to know the companies of its country better than the exporter
clients.
Functions of Factor:
A factor performs a number of functions for his client.
These functions are:
1. MAINTENANCE OF SALES LEDGER:
A factor maintains sales ledger for his client firm. An invoice is sent by the client to the
customer, a copy of which is marked to the factor. The client need not maintain individual sales
ledgers for his customers.
On the basis of the sales ledger, the factor reports to the client about the current status of his
receivables, as also receipt of payments from the customers and as part of a package, may
generate other useful information. With the help of these reports, the client firm can review its
credit and collection policies more effectively.
2. COLLECTION OF ACCOUNTS RECEIVABLES:
Under factoring arrangement, a factor undertakes the responsibility of collecting the receivables
for his client. Thus, the client firm is relieved of the rigours of collecting debts and is thereby
enabled to concentrate on improving the purchase, production, marketing and other managerial
aspects of the business.
With the help of trained manpower backed by infrastructural facilities a factor systematically
undertakes follow up measure and makes timely demand in the debtors to pay amounts.
Normally, debtors are more responsive to demands or reminders from a factor as they would not
like to go down in the esteem of credit institution as a factor.
3. CREDIT CONTROL AND CREDIT PROTECTION:
Another useful service rendered by a factor is credit control and protection. As a factor maintains
extensive information records (generally computerized) about the financial standing and credit
rating of individual customers and their track record of payments, he is able to advise its client
on whether to extend credit to a buyer or not and if it is to be extended the amount of the credit
and the period there-for.
Further, the factor establishes credit limits for individual customers indicating the extent to
which he is prepared to accept the client’s receivables on such customers without recourse to the
client. This specialized service of a factor assists clients to handle a far greater volume of
business with confidence than would have been possible otherwise.
In addition, factor provides credit protection to his client by purchasing without recourse to him
every debt of approved customers (within the stipulated credit limit) and assumes the risk of
default in payment by customers only in case of customers’ financial inability to pay.
4. ADVISORY FUNCTIONS:
At times, factors render certain advisory services to their clients. Thus, as a credit specialist a
factor undertakes comprehensive studies of economic conditions and trends and thus is in a
position to advise its clients of impending developments in their respective industries.
Many factors employ individuals with extensive manufacturing experience who can even advise
on work load analysis, machinery replacement programs and other technical aspects of a client’s
business.
Factors also help their clients in choosing suitable sales agents/seasoned personnel because of
their close relationship with various individuals and non-factored organizations.
Thus, as a financial system combining all the related services, factoring offers a distinct solution
to the problems posed by working capital tied in trade debts.
