What is factor?
A company can assign its credit
management and collection to
specialist organisations called the
factor organisation or the “factor”.
Factoring
Popular mechanism of managing, financing
and collecting receivables .
Method of converting a non-productive,
inactive asset (i.e. receivables) into a
productive asset (cash) by selling
receivables to a company that specialises in
there collection and administration.
A factor makes the conversion of
“receivables” into “cash” possible.
Factoring
Definition:
Factoring is defined as ‘a continuing legal
relationship between a financial institution
(factor) and a business concern (client)
selling goods or providing services to trade
customers (customer) whereby, the factor
purchases the clients accounts
receivables and in relation thereto,
controls the credit, extended to customers
and administers the sales ledger.
In Normal Business
CLIENT CUSTOMER
(Supplier of (Buyer of
goods and/or goods and/or
Services) Services)
Using Factoring
CLIENT CUSTOMER
(Supplier of (Buyer of
goods and/or goods and/or
Services) Services)
FACTOR
Functions of factor
Finance for the supplier, including loans
and advance payments.
Maintenance of accounts.
Collection of accounts.
Protection against default in payment by
debtors.
Issuing notice of assignment of the
receivables to debtors.
Mechanism of factoring
There are three parties to a domestic
factoring arrangement:
The client who is supplier or seller of goods and
services.
The customer who is a debtor or buyer of goods and
services provided by the client.
The factor who is a financial institution or intermediary
between client and customer who provides the
factoring services.
Different factoring services
Sales ledger administration and credit
management.
Credit collection and protection against
default and bad debt losses.
Financial accomodation / assistance
agaist the assisned book debts.
Different factoring services contd.
1. Credit administration/ management
Helps and advices the clients from the stage of
deciding credit extension to customers to the
final stage of bad debt collection.
Factor maintains an account for customers of
all items owing to them , so that collection could
be made on due date or before.
Helps clients to decide whether to give or not
and, how much credit extent to the customers
Provides info to clients about market trends ,
competition, and creditworthiness of customer.
Different factoring services
contd.
2. Credit collection and protection against
default
Factor undertakes all collection activity
when individual book debts become due
from the customer
Provides full or partial protection agaist
bad debts
Different factoring services contd.
3. Financial assistance/ accomodation against
the assigned book debts
Factors provide financial assistance to the
clients by extending advance cash against
book debts
Purchase the debts , allowing full credit
protection against any bad debts and
provide assistance against firms book debts
Types of factoring servicing
Full service non-recourse (old line)
Full service recourse factoring
Bulk/agency factoring
Non-notification factoring.
Full service non-recourse.
Factor undertakes to collect the debts from the
customer assuming 100 % risk.
Balance amount is paid to client at the end of
the credit period or when the customer pays the
factor whichever comes first.
The advantage of non recourse factoring is that
continuous factoring will eliminate the need for
credit and collection departments in the
organization.
Full service recourse factoring
Client undertakes to collect the debts from the
customer.
If the customer don't pay the amount on
maturity, factor will recover the amount from the
client.
This is the most common type of factoring.
Recourse factoring is offered at a lower interest
rate since the risk by the factor is low.
Balance amount is paid to client when the
customer pays the factor.
Bulk/agency factoring
Also called disclosed factoring .
client's customers are notified of the
factoring agreement.
Disclosed type can either be recourse or
non recourse
Non-notification factoring
Also called undisclosed factoring.
Client's customers are not notified of the factoring
arrangement.
Sales ledger administration and collection of debts
are undertaken by the client himself.
Client has to pay the amount to the factor
irrespective of whether customer has paid or not.
But in disclosed type factor may or may not be
responsible for the collection of debts depending
on whether it is recourse or non recourse.
Checking credit worthiness
Factor evaluated creditworthiness of the customer
(buyer of goods).
Checking credit information
Using :-
balance sheets, p/l account
Banks reference
Traders reference
Credit limit
Credit limit is maximum credit which firm
will extend at any point of time.
The decision will depend upon the
customer financial strengths.
The credit limit must be reviewed
periodically.
The firm should follow well laid down
collection policy.
Example…..
• Siemens( India) sells about 85% of its
products through dealers and remaining
15% is sold directly to large corporate
customers. generally a 45 day credit is
extended to dealers but a lot of variation
exist for different dealers.
Cost of factoring
These are two types of costs in factoring
services
1. Service Fee or Charges
Service fee is levied for the work involved in
administering the sales ledger as well as protection
against bad debts.
The service fee for domestic factoring ranges from
0.30 per cent to 0.75 per cent and it would be higher
when non-recourse arrangements are made.
Cost of factoring contd.
2. Discount Charge
The discount charge is levied on the advance provided
by the factor and is computed on the basis of prime
lending rate.
It is calculated on a day-to-day basis on the advances
outstanding,
Benefits of factoring
The client will be relieved of the work
relating to sales ledger administration and
debt collection.
The client can therefore concentrate more
on planning production and sales.
Firm can save the cost of credit
administration.
For the purpose of preventing defaults and
bad debts.
Disadvantages of Factoring
Image of the client may suffer as engaging a
factoring agency is not considered good sign of
efficient management.
Factoring may not be much use where companies
or agents have one time sales with the customers.
Factoring increases cost of finance & thus cost of
running the business.
If the client has cheaper means of finance & credit,
factoring may not be useful.
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