* FACTORING SERVICES Concept : Domestic factoring An arrangement in which receivables are sold by the client to the factor , a financial intermediary and the title to goods /services represented by those receivables passes to the factor. The factor becomes responsible for collection, follow up, sales ledger administration, credit protection as per agreement with seller.

seller, factor and buyer all reside in the same country, hence domestic factoring

*MechanismThe Buyer: 1. Negotiates the terms of sale2. Receives goods with invoice and instructions to pay to factor on due date3. Pays to factor in time or gets extension or in case of default faces legal action The SellerMOU with buyer and sells as per MOUDelivers to factor, the copies of invoice , delivery challan, MOU, instructions to pay to factorSeller receives from factor, 80-85 % advance after deduction of the factors service chargesSeller gets balance payment after invoice is finally paid

*The factorEnters into agreements with seller Pays 80-85% to seller on receipt of copies of invoice and other documents ConditionsThe invoice /bill and documents mention that these receivables be factoredReceivables on the bills are unencumberedDeed of assignment is executedAcknowledgment of buyer for assignment notice or signed MOUAll terms of sale purchase contract are fully compliedLetter of waiver from banker having charge on goods sold to buyer Gets paid by buyer on due date and remits balance payment after service charges to seller

*Functions of a factorA. Sales ledger administration (legal status: agent)Seller sends Invoice to buyer and copy to factorLedger kept by factor on open item method i.e each receipt matched against the specific invoice3. Gives reports to seller client periodically on status on receivables and receipts and any other information4. Customer wise record of payment kept to judge patterns of payments or delays or defaults

*B. Collection of receivables (legal status: agent)

Collection function on behalf of client

C. Financing trade debts (legal status: assignee of debt)

Main function is to purchase receivables and give advance unto 80-85% of assigned debtsRetained amount 15-20% is called factor reserve

Factor reserves released after realization of dues

*D. Advisory servicesSpecialized Knowledge , Experience in finance, Access to credit information1. Customers perception of sellers products thru surveys 2. Changes in marketing strategies & Emerging trends3. Audit of procedures for invoicing , delivery, dealing with sales returns4. Introduction to credit debt of a bank engaged in merchant banking / HP /leasing for such needs

*Collection factoring or Maturing factoringPayment made to client on realization of duesor on guaranteed payment date (date fixed as due date plus delay observed incollection from customer )

Full factoring: All factoring services given

Disclosed factoring : name of factor disclosed in invoice and buyer to make payment to factor

Undisclosed factoring: name of factor not disclosed in invoice but services provided by the factor Bank participation factoring: Bank participates

* Advance factoring 80- 85% of invoice value paid in advance Retained amount 15-20% is called factor reserve released after realization of dues Recourse factoring Does not assume risk and has recourse to seller in case of default by buyer. Without recourse factoring Assumes credit risk without recourse to seller and as a compensation, charges higher commission called del credere Fixes credit limits for approved customers in consultation with clients

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Advantages to seller : i. Relieves client from this to focus on more importantii. Client saves manpower time and effortsiii. Factor uses trained manpower with sophisticated infrastructure, timely and systematic follow upiv. Buyer more responsive to the factor, a credit institution May take legal action on default in consultation with selle customer vi. Better credit control on existing and potential customers thru Extensive info and network & database of factor on customers Payment track record , Financial standing information, Credit rating Periodic reports on customer outstanding,, ageing schedules for seller to decide further credit sale to a particular customer

*Credit line by factor for a customer of seller: Based on financial position, track record, value of goods sold by client

Monthly Turnover 20 lakh Credit 60 Days

Automatically approved monthly credit line = 20 lakh x 30/60 =10 lakh

*Charge for services:Collection and Sales ledger administration:

Front end Commission as % age of debt purchased; 0.5% to 2% for recourse factoring 3-4% for without recourse factoringShort term financing

Discount charges / interest as per prevailing rates

*Factroing vs bills discountingSimilaritiesBoth provide short term financedBoth discount the future receivablesDifferences Bill discounting FactoringWith recourse always With or without recourseSeller responsible for Factor to collect debts collection and payment . .3. Only finance provided All services provided4. Rediscounting of bills Refinancing of debtsTransaction based Bulk finance against unpaid invoices invoices on continuous basis No assignment of debt Assignment of debt .7. Contingent liability Contingent liability in with recourse & off balance . sheet in without recourse

*International factoring International Institute for The Reunification Of Private Law (UNIDROIT) , Rome 1988 An arrangement between a factor and his client that includes at least two of the following services provided by the factor:FinanceMaintenance of accounts Collection of debtsProtection against credit risk

*Export / cross border / internationalfactoring: Exporter (seller), Signs contract export factor, credit info import factor(Language, Legal formalities, underwrites credit risk, Importer (buyer) Sales ledger, collects, transfers) Also called two factor system of factoring

*Forfeiting:Factoring by way of discount of availed trade bills/ promissory notes by a bank or FI without recourse to seller assuming full credit risk MechanismExporter sends goods to importer on deferred payment basis say Rs. 20 lakh payable in 5 half yearly installments of Rs 4 lakh plus intt.Importer draws a series of Promissory Notes (5 in this case) with inertest fvg. exporter or accepts series of bills of exchange drawn by exporter. 3. The promissory notes or bills are avalled or guaranteed by a bank by endorsement on bill on behalf of importer.

*4.These avalled bills are sent to exporter.

5.The exporter sells to forfaitor (bank or FI) avalled bills at discount without recourse based on credit rating of avalling bank, and country risk of importer and gets 100% value less discount charges

6. Forfaitor may hold the bills for payment by the availing bank on due date

or may sell in secondary market as high yielding unsecured debt paper for liquidity.

* Forfaiting Export factoring

100 % discounting 75-85% discounting

Decision based on Decision based on credit standing of standing of exporter and avalling bank credit protection process

Pure financing Many services

Deferred credit 3-5 years Short term finance

Premium charged for Exchange rate risk Exchange risk protection not guarded

*Factoring scenario in IndiaKalyan Sundaram Committee Recommendations for export factoringServices 1989RBI directives in 19901. Banks allowed factoring services thru subsidiaries2. Banks investment not to exceed 10% of its paid up capital and reserves3. Zone wise four banks SBI ( Western) Canara bank (southern) PNB( northern) Allhabad bank (eastern)

*1. SBI FACS Ltd (SBI Factors and Commercial Services Ltd)1991 SBI, Union bank, Sidbi Member of Factors Chain International, Amsterdam andEDIFACT Communication Network of the Factors Chain International Electronic Data Interchange

2. Canbank Factors Ltd. 606 cr. 20031992 Canara, Allhabad, Sidbi 60:20:20 1223cr 2003

3. Foremost Factors Ltd. Joint venture promoted by National Bank of America, 250 cr 2003

4. Global Trade Factors LtdEXIM bank of india, IFC, West LB, Germany factoring andforfaiting

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*Illustration: Value of factored receivables Rs. 20 lakh for 90 days Max. advance @ 80%, Collection cum sales ledger Commission 2% (up front)Interest rate 20% compounded quarterly Work out the advance payable to the seller

1. Value of advance = 20 lakh x 80% = 16.00 lakh2. Less commission = 20 lakh x .02 = - 0.40 lakh 15.60 lakh3. Less discount= 16 x 0.20 x 90/360 = - 0.80 lakh4. Amount payable to seller = 14.80 lakh effective cost of funds/ interest rate to seller as% of funds = 0.80/15.60 x100=5.13%Int charge per quarter n 4Inter charge per annum= [ (1+r) - 1]=(1.0513 ) 1 =1.2215-1 = 0.2215 = 22.15%

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