Factoring
Introduction
Firms sell goods on both cash and credit basis. When goods are sold on credit, bills
are drawn on the buyer by the seller. This practice, while common, can tie up
significant working capital, particularly for small and medium businesses, impacting
their liquidity.
In the case of small and medium businesses, a considerable part of their working
capital is tied up in bills receivable. This affects the firm’s liquidity position and
hinders the smooth functioning of the business. To overcome this hurdle, factoring
as a service has emerged.
What is Factoring?
Factoring is derived from the Latin term “facere”, which means “to make or do”. It is an arrangement
wherein the trade debts of a company are sold to a financial institution at a discount. This allows
businesses to convert their accounts receivable into immediate cash, improving their financial flexibility.
According to the Reserve Bank of India (Mr. C. S. Kalyanasundaram): “Factoring is a continuing
arrangement under which a financing institution assumes the credit and collection functions for
its clients, purchases receivables as they arise (with or without recourse for credit losses, i.e., the
customer’s financial inability to pay), maintains the sales ledgers, attends to other book-keeping
duties relating to such accounts, and performs other auxiliary duties.”
The factor is an agent who buys the accounts receivable (Debtors and Bills Receivables) of a firm and
provides finance to meet working capital requirements. The main advantage of factoring is that it allows
both small and large businesses to receive short-term finance (working capital) to meet day-to-day
payments.
Factoring Process
1 Agreement with Factor
The firm enters into a factoring arrangement with a factor, which is generally a financial institution, for invoice
purchasing.
2 Invoice Submission
Whenever goods are sold on credit basis, an invoice is raised and a copy of the same is sent to the factor.
3 Debt Assignment
The debt amount due to the firm is transferred to the factor through assignment and the same is intimated to the
customer.
4 Collection by Factor
On the due date, the amount is collected by the factor from the customer.
5 Funds Remittance
After retaining the service fees, the remaining amount is sent to the firm by the factor.
Features of Factoring
Book-Debts Maintenance Credit Coverage Cash Advances
A factor takes the responsibility of maintaining The factor accepts the risk burden of loss of bad Around eighty percent of the total amount of
the accounts of debtors of a business institution. debts leaving the seller to concentrate on his accounts receivables is paid as advance cash to
This streamlines financial record-keeping. core business. This offers crucial protection. the client. Immediate liquidity is a major
benefit.
Collection Service Client Advice
Issuing reminders, receiving part payments, From the past history of debtors, the factor is
collection of cheques form part of the factoring able to provide advices regarding the credit
service. This frees up client resources. worthiness of customers, perception of
customers about the products of the client, etc.
This offers valuable business insights.
Types of Factoring
Full Service/Without Recourse Factoring With Recourse Factoring
When a factor agrees to provide complete set of services When the factor does not undertake credit risk, it is known as
which includes financing, maintenance of sales ledger, debt with recourse factoring. In case the debtor fails to make the
collection at his own risk, and providing consultancy services payment on due date, it is assigned back to the firm by the
as and when necessary, it is called as full servicing factoring. factor. Here the responsibility of collecting the amount lies
with the selling firm.
Maturity Factoring International Factoring
In this type, the factor agrees to finance the firm only after When the claims of an exporter are assigned to a financial
collecting the amount on maturity from debtors. institution and the finance is advanced on the basis of export
invoice it is called as international factoring.
Factoring vs. Forfaiting
Factoring Forfaiting
Forfaiting is defined as “the non-recourse purchase
Focuses on short-term domestic by a bank or any other financial institution of
receivables, often with ongoing receivables arising from an export of goods and
services”.
arrangements and a broader range of
It typically involves larger, medium-to-long term
services.
international trade receivables, usually without
recourse.
Factoring Companies in India
Here are some prominent factoring companies in India, providing essential financial services:
Canbank Factors Limited
SBI Global
IFCI Factors Limited
Export Credit Guarantee Corporation of India Ltd
Small Industries Development Bank of India (SIDBI)
Conclusion:
Factoring helps smooth running of business by getting short term
credits from financial institutions against accounts receivables.
Forfaiting is a variation of factoring with focus on international
exports.
By understanding and utilizing factoring, businesses can significantly
improve their cash flow, mitigate credit risks, and focus on their core
operations, paving the way for sustainable growth.
Thank You!
