UNIT – III UNIT – III FACTORINGFACTORING

BILL DISCOUNTINGBILL DISCOUNTING

FACTORINGFACTORING

TOPICS TOPICS ► CONCEPTCONCEPT► PROCESSPROCESS► FORMSFORMS► FUNCTIONSFUNCTIONS► LEGAL ASPECTSLEGAL ASPECTS► FINANCIAL EVALUATIONFINANCIAL EVALUATION► COST OF FACTORINGCOST OF FACTORING► DECISION ANALYSISDECISION ANALYSIS► FACTORING SCENARIO IN INDIAFACTORING SCENARIO IN INDIA

INTRODUCTIONINTRODUCTION►Two types of problemsTwo types of problems: :

problem of raising funds to finance, problem of raising funds to finance, problems relating to collection, problems relating to collection,

delays and defaults of the delays and defaults of the receivablesreceivables

►Proper control and mgt of receivables - Proper control and mgt of receivables - factoring firmsfactoring firmsRBI Committee headed by Shri C S Kalyan RBI Committee headed by Shri C S Kalyan

Sundaram Sundaram basis- SBI(1991)Subsidiary(SBI Factors Ltd) basis- SBI(1991)Subsidiary(SBI Factors Ltd)

capital of Rs 25 crores – western zone.capital of Rs 25 crores – western zone.

MEANINGMEANING►Derived form latin word – Derived form latin word – “Facere”“Facere” – –

to make or to do. To get things to make or to do. To get things donedone

►FACTORFACTOR: is an agent, as a banking or : is an agent, as a banking or insurance company, engaged in insurance company, engaged in financing the operations of certain financing the operations of certain companies or in financing wholesale or companies or in financing wholesale or retail trade sales, through retail trade sales, through the the purchase of account receivables.purchase of account receivables.

FACTORINGFACTORING► It is It is method of financingmethod of financing whereby a whereby a

company sells its trade debts at a company sells its trade debts at a discount to a financial institution.discount to a financial institution.

COMPANYSELLS FACTOR

CUSTOMERSWHO HAVE

TO PAY

FIs, banks, insurance cos

seller Debtor/buyer

DEFINITION according to DEFINITION according to International Institute for the International Institute for the

Unification of Pvt. Law-Unification of Pvt. Law-(UNIDROIT)(UNIDROIT)►Arrangement between a factor and his Arrangement between a factor and his

client which includes atleast two of the client which includes atleast two of the following services:following services:

►FinanceFinance►Maintenance of accountsMaintenance of accounts►Collection of debtsCollection of debts►Protection against credit risksProtection against credit risks

ACCORDING TO V A ACCORDING TO V A AVADHANIAVADHANI

Factoring is a service of financial Factoring is a service of financial nature involving the conversion of nature involving the conversion of credit bills into cashcredit bills into cash

FACTORINGFACTORING

SELLER

FACTOR

BUYER

80%OF

INVOICE&

20% LATER

payment

Invoice & notice

of ass

ignment

Invo

ice

NATURE OF FACTORINGNATURE OF FACTORING► Fund based service/asset basedFund based service/asset based► Conversion of credit bills into cashConversion of credit bills into cash► Risk taken overRisk taken over► FIs – mgt. & financing of debts arising out of FIs – mgt. & financing of debts arising out of

credit salescredit sales► Specializes in handling & collecting receivables Specializes in handling & collecting receivables

in efficient manner.in efficient manner.► Sales accounting, debt collection and credit Sales accounting, debt collection and credit

control protection from bad debts & rendering control protection from bad debts & rendering advisory servicesadvisory services

► Release funds tied up in credit & solve problems Release funds tied up in credit & solve problems – collection, delays & defaults– collection, delays & defaults

MECHANISMMECHANISM

SELLING FIRM FACTOR CUSTOMERS RECEIVABLES

1

SALE OF GOODS(2)

agreement

Invoice copy(3)

paymentsAdvance payement/discounting(4)

Final payment after deductingFess and charges if any(5)

PARTIES:PARTIES:

BUYERBUYERSELLERSELLERFACTORFACTOR

Characteristics of Characteristics of factoringfactoring

1.1. Period for factoring is Period for factoring is 90 to 150 days90 to 150 days. . Some >Some > 150 days 150 days. .

2.2. A A costly source of financecostly source of finance compared to compared to other sources of short term other sources of short term borrowings. borrowings.

3.3. Factoring receivables is an Factoring receivables is an ideal ideal financial solutionfinancial solution for new and for new and emerging firms without strong emerging firms without strong financials. financials.

4.4. Bad debts will not be consideredBad debts will not be considered 5.5. Credit rating is not mandatory. But the Credit rating is not mandatory. But the

factoring companies usually factoring companies usually carry out carry out credit risk analysiscredit risk analysis before entering into before entering into the agreement. the agreement.

6.6. Cost of factoring=finance cost + operating Cost of factoring=finance cost + operating costcost(vary according to the transaction si(vary according to the transaction size, ze, financial strength of the customer etc). ( financial strength of the customer etc). ( 1.5% 1.5% to 3%to 3% per month depending upon the financial per month depending upon the financial strength of the client's customer).strength of the client's customer).

7.7. Indian firms offer factoring for invoices Indian firms offer factoring for invoices as low as low as 1000Rsas 1000Rs

8.8. Delayed payments beyond the approved credit Delayed payments beyond the approved credit period, period, penal charge of around 1-2% per penal charge of around 1-2% per monthmonth over and above the normal cost is over and above the normal cost is charged (it varies like 1% for the first month charged (it varies like 1% for the first month and 2% afterwards).and 2% afterwards).

FUNCTIONS OF A FACTORFUNCTIONS OF A FACTOR►Purchase and collection of debtsPurchase and collection of debts►Sales ledger managementSales ledger management►Credit investigation and undertaking of Credit investigation and undertaking of

credit riskcredit risk►Provision of finance against debtsProvision of finance against debts►Rendering consultancy servicesRendering consultancy services

OTHER FUNCTONS OF OTHER FUNCTONS OF FACTORFACTOR

► A Factor offers:A Factor offers:

 •  • Instant CashInstant Cash  •   • Follow up and Speedy CollectionFollow up and Speedy Collection  •   • MIS ServicesMIS Services  •  • Sales Ledger Administration.Sales Ledger Administration.  •  • Credit Protection.Credit Protection.  •   • Advisory Services.Advisory Services.   

TYPES OF FACTORINGTYPES OF FACTORING1.1. Full serviceFull service2.2. With recourseWith recourse3.3. Maturity(collection)Maturity(collection)4.4. Invoice factoring (only finance)Invoice factoring (only finance)5.5. Agency factoring Agency factoring 6.6. International/cross-borderInternational/cross-border7.7. Limited Limited 8.8. Selected buyer based factoringSelected buyer based factoring9.9. Selected seller basedSelected seller based10.10. Bulk or disclosed or notified & Invoice or Bulk or disclosed or notified & Invoice or

undisclosed or confidential invoiceundisclosed or confidential invoice

BENEFITSBENEFITS►Ready cashReady cash►Funds-up to 80% of the factored invoices. Funds-up to 80% of the factored invoices. ►Competitive terms to your buyers and improve Competitive terms to your buyers and improve

your sales and ultimately profit.your sales and ultimately profit.►Liquidity will improve and therefore, your Liquidity will improve and therefore, your

production cycle will be accelerated.production cycle will be accelerated.►Appraisal and documentation procedures are Appraisal and documentation procedures are

made simple and response time is very small. made simple and response time is very small. ►Improves efficiency, credit standing position, Improves efficiency, credit standing position,

cash flowscash flows►Better position, purchase planning, mgt of Better position, purchase planning, mgt of

receivables – impact on balance sheetreceivables – impact on balance sheet

►Classified periodical statement of outstanding Classified periodical statement of outstanding invoices.invoices.

► favorable credit period with liberal grace favorable credit period with liberal grace periods.periods.

►Minimum-security formalities.Minimum-security formalities.►Replaces high cost market credit and enables Replaces high cost market credit and enables

purchases on cash basis availing cash discounts .purchases on cash basis availing cash discounts .►Each invoice is followed up for payment.Each invoice is followed up for payment.►Faster collection & Lowest response time.Faster collection & Lowest response time.►Provides flexibility Provides flexibility ►Helps in boosting the efficiency ratios.Helps in boosting the efficiency ratios.►Saves the mgt time & effort.Saves the mgt time & effort.►Avoid bad debts & off balance sheet financeAvoid bad debts & off balance sheet finance

FINANCIAL IMPLICATIONSFINANCIAL IMPLICATIONS► Impact on Balance SheetImpact on Balance Sheet►Off Balance sheet financeOff Balance sheet finance► Improves Current Ratio, credit Improves Current Ratio, credit

standing, efficiencystanding, efficiency►Reduction of cost and expensesReduction of cost and expenses►Additional sourceAdditional source

BALANCE SHEET: PRE-BALANCE SHEET: PRE-FACTORING SCENARIOFACTORING SCENARIO

CL & NWCCL & NWC CACABank borrowings:Bank borrowings:Cash credit(inve) 70Cash credit(inve) 70CC (Receiv) 40 CC (Receiv) 40 110 110

Inventory 100Inventory 100Receivables 80Receivables 80

Other CL Other CL 40 40 NWC NWC 5050

Other current assets Other current assets 2020

200 200 current ratio = current ratio = 1.33:11.33:1

200200

CL & NWCCL & NWC CACABank borrowings:Bank borrowings:Cash credit(inve) 70Cash credit(inve) 70CC (Receiv) - CC (Receiv) - 70 70

Inventory 100Inventory 100Due from factor 16Due from factor 16

Other CL Other CL 16 16 NWC NWC 5050

Other current assets Other current assets 2020

136 136 current ratio: current ratio: 1.58:1.1.58:1.

136136

BALANCE SHEET: Post -BALANCE SHEET: Post -FACTORING SCENARIOFACTORING SCENARIO

LIMITATIONSLIMITATIONS►Over-confidence- overtradingOver-confidence- overtrading►Fraudulent actsFraudulent acts►Lack of professionalism and Lack of professionalism and

competence, underdeveloped competence, underdeveloped expertise, resistance to change….expertise, resistance to change….

►Rights are uncertain.Rights are uncertain.►Sometimes not suitable to enter.Sometimes not suitable to enter.

LEGAL ASPECTSLEGAL ASPECTS► Subject to terms and conditions Subject to terms and conditions ► Warants – receivables are valid, Warants – receivables are valid,

enforceable, undisputed, recoverableenforceable, undisputed, recoverable► Agrees bills – non- recourse basisAgrees bills – non- recourse basis► Agrees to service notice of assignmentsAgrees to service notice of assignments► Provide copies of all invoices, credit notes…Provide copies of all invoices, credit notes…► Sole factorSole factor► submit to factor – all salessubmit to factor – all sales► Grant the factor to hold any balancesGrant the factor to hold any balances

► Time frame for the agreement and mode of Time frame for the agreement and mode of transmission transmission

► Letter of disclaimer from bankLetter of disclaimer from bank► To act swiftlyTo act swiftly► Approves and unapproved debtsApproves and unapproved debts► WarrantsWarrants► Disputed debtDisputed debt► Inspect firm’s books & accountsInspect firm’s books & accounts► No double financingNo double financing► Genuine trade transactionGenuine trade transaction► Personal guaranteePersonal guarantee► Transfer of property section 130 Transfer of property section 130

FACTORING SERVICES IN FACTORING SERVICES IN INDIAINDIA

Kalyansundaram study group appointed Kalyansundaram study group appointed by RBI in 1989.by RBI in 1989.

RBI guidelines for factoring services – RBI guidelines for factoring services – 19901990

KALYAN SUNDARAM COMMITTEE KALYAN SUNDARAM COMMITTEE RECOMMENDATIONSRECOMMENDATIONS

► Sufficient scope for introductionSufficient scope for introduction► Export FS – additional facility to exportersExport FS – additional facility to exporters► Commercially viable position within 2.3yrsCommercially viable position within 2.3yrs► To all industries and all sectorsTo all industries and all sectors► Mix of various sources of funds <13.5 % paMix of various sources of funds <13.5 % pa► Raise fundsRaise funds► Beginning only select promoter institutions/ Beginning only select promoter institutions/

groups of individualsgroups of individuals► Promoted under zonal basis – initially.-4 /5Promoted under zonal basis – initially.-4 /5► Suggested SIDBISuggested SIDBI

►Business community – educatedBusiness community – educated►Set up specialised agencies for credit Set up specialised agencies for credit

investigationsinvestigations►communication – ITcommunication – IT►Proper linkage between banks and Proper linkage between banks and

factorsfactors►SSI – benefitedSSI – benefited►ECGCECGC►Efficient factoring system – promoting Efficient factoring system – promoting

factoringfactoring

RBI GUIDELINESRBI GUIDELINES►Banks cannot directly/departmentally Banks cannot directly/departmentally

undertake the business of factoring- undertake the business of factoring- can invest. But now – cancan invest. But now – can

►Not engage in financing of other Not engage in financing of other companies or other factoring companies or other factoring companies.companies.

►Share <10 % paid – up capital & Share <10 % paid – up capital & reserves of bankreserves of bank

RBI IDENTIFIEDRBI IDENTIFIED►SBI – western regionSBI – western region►CANARA BANK – south zoneCANARA BANK – south zone►PUNJAB NATIONAL BANK – northern PUNJAB NATIONAL BANK – northern

regionregion►ALLAHABAD BANK – eastern zoneALLAHABAD BANK – eastern zone

SBI FACTORS & COMMERCIAL SBI FACTORS & COMMERCIAL SERVICES (SBI FACS ) LTDSERVICES (SBI FACS ) LTD

►SBI , UNION BANK OF INDIA AND SIDBI SBI , UNION BANK OF INDIA AND SIDBI – March 1991 – promoted – – March 1991 – promoted – commenced operation april 1991.commenced operation april 1991.

►Associate member of factors chain Associate member of factors chain international – Amsterdam.- EDIFACTinternational – Amsterdam.- EDIFACT

►Paid up capital – 25 crores, 35% Paid up capital – 25 crores, 35% market sharemarket share

CANBANK FACTORS LTDCANBANK FACTORS LTDCanara Bank, Andhra Bank & SIDBI- Canara Bank, Andhra Bank & SIDBI-

August 1992.August 1992.Paid –up capital 10 crorers, 60:20:20Paid –up capital 10 crorers, 60:20:20

OTHER FACTORSOTHER FACTORS►Foremost FACTORS LTD :Foremost FACTORS LTD : Joint Joint

venture with Natinal bank of america venture with Natinal bank of america (1997)- 20 crores- annual turnover – (1997)- 20 crores- annual turnover – 250 crore- pioneered export factoring 250 crore- pioneered export factoring

►Global Trade Finance Global Trade Finance Ltd(GTF):Ltd(GTF):jointly by EXIM bank of india, jointly by EXIM bank of india, International Finance corporation & International Finance corporation & West LB, Germany- Paid –up Capital 45 West LB, Germany- Paid –up Capital 45 crorecrore

Factoring companies in Factoring companies in IndiaIndia

► Canbank Factors Limited: Canbank Factors Limited: http://www.canbankfactors.comhttp://www.canbankfactors.com► SBI Factors and Commercial Services SBI Factors and Commercial Services

Pvt. Ltd: Pvt. Ltd: http://www.sbifactors.com

► The Hongkong and Shanghai Banking The Hongkong and Shanghai Banking Corporation Ltd: Corporation Ltd: http://www.hsbc.co.in/in/corp/factserv.htm

► Foremost Factors Limited: Foremost Factors Limited: http://www.foremostfactors.net

►Global Trade Finance Limited: Global Trade Finance Limited: http://www.gtfindia.com

►Export Credit Guarantee Export Credit Guarantee Corporation of India Ltd: Corporation of India Ltd: http://www.ecgcindia.com

►Citibank NA, India: Citibank NA, India: http://www.citibank.co.in

►Small Industries Development Small Industries Development Bank of IndiaBank of India ( (SIDBISIDBI): ): http://www.sidbi.in/fac.asp

OPERATIONAL PROBLEMSOPERATIONAL PROBLEMS►Credit INFORMATIONCredit INFORMATION►Stamp duty Stamp duty ►Legal frameworkLegal framework►FundingFunding►Disclaimer certificateDisclaimer certificate►Limited coverageLimited coverage

EVALUATION FRAMEWORK- TWO EVALUATION FRAMEWORK- TWO ATERNATIVES TO RECEIVABLE ATERNATIVES TO RECEIVABLE

MGTMGT► IN-HOUSE MANAGEMENT BY THE FIRM IN-HOUSE MANAGEMENT BY THE FIRM

ITSELFITSELF►FACTORING SERVICE – RECOURSE OR FACTORING SERVICE – RECOURSE OR

NON-RECOURSENON-RECOURSE

COST ASSOCIATED WITH IN-COST ASSOCIATED WITH IN-HOUSE MANAGEMENTHOUSE MANAGEMENT

1.1. Cash discountCash discount2.2. Cost of funds in receivables (Avg Cost of funds in receivables (Avg

collection period, cost of bank collection period, cost of bank finance + cost of own funds)finance + cost of own funds)

3.3. Bad debt lossesBad debt losses4.4. Lost contribution on foregone salesLost contribution on foregone sales5.5. Avoidable cost of sales ledger Avoidable cost of sales ledger

administration and credit monitoringadministration and credit monitoringTotal cost = 1+ 2+ 3+ 4+ 5

COSTS ASSOCIATED WITH COSTS ASSOCIATED WITH RECOURSE & NON- RECOURSE RECOURSE & NON- RECOURSE

FACTORINGFACTORING►Factoring commissionFactoring commission►DISCOUNT CHARGEDISCOUNT CHARGE►Cost of long – terms funds invested in Cost of long – terms funds invested in

receivablesreceivables

DECISION ANALYSISDECISION ANALYSIS►Benefits with recourseBenefits with recourse : Cost : Cost

associated with in-house mgt except- associated with in-house mgt except- bad debt lossesbad debt losses

►Benefits with non-recourseBenefits with non-recourse : Cost : Cost associated with in-house mgt associated with in-house mgt

Net benefit : Benefits - Costs

END OF FACTORING

REFERENCESREFERENCES►http://www.languages.ind.in/factoring.

htm►http://www.search4i.com/54454/Direc

tory/Factoring.aspx►Financial Services by M Y KHANFinancial Services by M Y KHAN►Emerging scenario of Financial Emerging scenario of Financial

services – Gordon & Natarajanservices – Gordon & Natarajan►Financial services by Shashi K Gupta Financial services by Shashi K Gupta

& Nisha Agarwal& Nisha Agarwal►Websites of factorscompaniesWebsites of factorscompanies

BILL DISCOUNTINGBILL DISCOUNTING

Introduction Introduction ► a bill of exchange issued by ABC Company to its a bill of exchange issued by ABC Company to its

client, XYZ Company. ABC Company decides to client, XYZ Company. ABC Company decides to cash in the outstanding bill in order to make use of cash in the outstanding bill in order to make use of the revenue now rather than later. To this end ABC the revenue now rather than later. To this end ABC approaches a bank with an offer to sell the bill for approaches a bank with an offer to sell the bill for 90% of the par value. The bank looks over the 90% of the par value. The bank looks over the transaction and decides the deal is viable. Upon transaction and decides the deal is viable. Upon approval, ABC receives 90% of the par value of the approval, ABC receives 90% of the par value of the bill and instructs XYZ Company to remit payment bill and instructs XYZ Company to remit payment to the bank. Once the bank receives full payment to the bank. Once the bank receives full payment from XYZ, the deal is considered complete.from XYZ, the deal is considered complete.

►The bill of exchange (B/E) is used for financing The bill of exchange (B/E) is used for financing a transaction in goods which means it is a transaction in goods which means it is essentially a trade related instrument.essentially a trade related instrument.

►According to Negotiable Instruments Act, According to Negotiable Instruments Act, 1881: “The bills of exchange is an instrument 1881: “The bills of exchange is an instrument is writing, containing an unconditional order, is writing, containing an unconditional order, signed by the maker, directing a certain signed by the maker, directing a certain person to pay a certain sum of money, only to, person to pay a certain sum of money, only to, or to the order of, a certain person, or to the or to the order of, a certain person, or to the bearer of that instrument”.bearer of that instrument”.

DEFINITIONDEFINITION►Acc to INDIAN NEGOTIABLE act,1881Acc to INDIAN NEGOTIABLE act,1881::The bill of exchangeThe bill of exchange is an instrument is an instrument

in writing containing an unconditional in writing containing an unconditional order, signed by the maker, directed a order, signed by the maker, directed a certain person to pay a certain sum of certain person to pay a certain sum of money only to or to the order of, a money only to or to the order of, a certain person, or to the bearer of that certain person, or to the bearer of that instrument”instrument”

Types of BillsTypes of Bills11►1 1 Demand Bill Demand Bill – Payable immediately on – Payable immediately on

presentment to employee.presentment to employee.►2. 2. Usance Bill Usance Bill – Time period recognized for – Time period recognized for

payment of bills.payment of bills.►3 3 Documentary BiDocumentary Bill – These B/E are accompanied ll – These B/E are accompanied

by documents that confirm trade has taken place.by documents that confirm trade has taken place.►4. 4. Clean Bills Clean Bills – These Bills are not accompanied by – These Bills are not accompanied by

any documents. Interest rate charged is higher any documents. Interest rate charged is higher than documentary bill.than documentary bill.

►

Creation of B/ECreation of B/E► Two parties i.e. seller sells goods or merchandise to Two parties i.e. seller sells goods or merchandise to

a buyer.a buyer.► Seller would like to be paid immediately but buyer Seller would like to be paid immediately but buyer

would like to pay after sometime.would like to pay after sometime.► Seller draws a B/E of a given maturity on the buyer.Seller draws a B/E of a given maturity on the buyer.► Seller (Creditor) becomes drawer of the bill and Seller (Creditor) becomes drawer of the bill and

buyer (Debtor) becomes drawee of the bill.buyer (Debtor) becomes drawee of the bill.► Seller sends the bill to buyer for his acceptance.Seller sends the bill to buyer for his acceptance.► Acceptor may be buyer himself or third party.Acceptor may be buyer himself or third party.►

PARTIES INVOLVEDPARTIES INVOLVED►SELLER-SELLER-Drawer of the bill.(Creditor)Drawer of the bill.(Creditor)► BUYER--BUYER--Drawee of the bill.(Debtor).Drawee of the bill.(Debtor).

►Buyer is responsible for payment of Buyer is responsible for payment of the bill on the maturity date.the bill on the maturity date.

►(Maturity means date on which (Maturity means date on which payment will fall normally it will be payment will fall normally it will be 30,60,90 or 120 days30,60,90 or 120 days but bill maturing but bill maturing within within 90 days is most popular90 days is most popular))

DISCOUNTING OF A B/EDISCOUNTING OF A B/E►The act of handing over an B/E for ready The act of handing over an B/E for ready

money is called money is called discounting of a B/Ediscounting of a B/E..►The difference between ready money The difference between ready money

paid and the face value of the bill is paid and the face value of the bill is called called DiscountDiscount..

► First:First: Hold on the B/E till maturity and take Hold on the B/E till maturity and take the payment from the buyer.the payment from the buyer.

► SecondSecond:Discount the B/E with a discounting :Discount the B/E with a discounting agency.agency.

Discounting of B/EDiscounting of B/E► Holder of an accepted B/E has two optionsHolder of an accepted B/E has two options

► Hold on to B/E till maturity and then take the Hold on to B/E till maturity and then take the payment from the buyer.payment from the buyer.

► Discount the B/E with discounting agency.Discount the B/E with discounting agency.

► The act of handing over an endorsed B/E for The act of handing over an endorsed B/E for ready money is called discounting the B/E. The ready money is called discounting the B/E. The margin between the ready money paid and face margin between the ready money paid and face value of the bill is called the discountvalue of the bill is called the discount

CONT..CONT..►The maturity of a B/E is defined as The maturity of a B/E is defined as

the date on which payment falls due.the date on which payment falls due.►Normal maturity periods are 30, 60, Normal maturity periods are 30, 60,

90 or120 days.90 or120 days.►Bills maturing within 90 days are Bills maturing within 90 days are

most popular. most popular. ►Discounting agencies are banks, Discounting agencies are banks,

NBFC, company, high net worth NBFC, company, high net worth individuals etcindividuals etc

Advantages to investorsAdvantages to investors►Short-term source of finance.Short-term source of finance.►Since it is not lending, no tax at source is Since it is not lending, no tax at source is

deducted while making the payment charges deducted while making the payment charges which are very convenient.which are very convenient.

►Rates of discount are betterRates of discount are better►Flexibility, not only in the quantum of Flexibility, not only in the quantum of

investments but also the duration of investments but also the duration of investments.investments.

►

Advantages to BanksAdvantages to Banks► Safety Funds – B/E Safety Funds – B/E is a negotiable instrument bearing is a negotiable instrument bearing

the signature of two parties considered good for the the signature of two parties considered good for the amount of bill, so he can enforce his claim easily.amount of bill, so he can enforce his claim easily.

► Certainty of Payment Certainty of Payment – A B/E is a self liquidating asset – A B/E is a self liquidating asset with the banker knowing in advance the date of its with the banker knowing in advance the date of its maturity.maturity.

► Profitability – The discount on bill is front ended, the Profitability – The discount on bill is front ended, the yield is much higher than in the other loans and yield is much higher than in the other loans and advances, where interest paid quarterly or half advances, where interest paid quarterly or half yearly.yearly.

►

TYPES OF BILLSTYPES OF BILLS1.1. DEMAND BILL- DEMAND BILL- NO TIME OR DUE DATE IS NO TIME OR DUE DATE IS

SPECIFIED.SPECIFIED.

2.2. USANCE BILL/TIME BILL.USANCE BILL/TIME BILL.3.3. DOCUMENTARY BILLS.(D/A,. D/P)DOCUMENTARY BILLS.(D/A,. D/P)4.4. CLEAN BILLS.CLEAN BILLS.

ADVANTAGESADVANTAGESTO INVESTORSTO INVESTORS::1.1. Short-term sources of finance.Short-term sources of finance.2.2. It is not lending, no tax at source is deducted It is not lending, no tax at source is deducted 3.3. Rate of discount are better.Rate of discount are better.4.4. FlexibleFlexibleTO BANKS:TO BANKS:1.1. Safety of funds.Safety of funds.2.2. Certainty of paymentCertainty of payment3.3. Profitability.Profitability...

DIFFERENCEDIFFERENCE

1.1. With recourse.With recourse.2.2. Drawer Drawer

responsibility of responsibility of collecting the bill collecting the bill and remitting the and remitting the proceeds to financing proceeds to financing agency.agency.

3.3. Provision of finance.Provision of finance.4.4. They can be They can be

rediscounted several rediscounted several times before mature.times before mature.

5.5. Only individual –Only individual –transaction-oriented.transaction-oriented.

1.1. With or with out recourse.With or with out recourse.2.2. Factor usually undertakes Factor usually undertakes

to collect the bills of the to collect the bills of the client.client.

3.3. Provides other services like Provides other services like sales ledger maintenance sales ledger maintenance and advisory services.and advisory services.

4.4. They cannot be They cannot be rediscounted but can be rediscounted but can be refinanced.refinanced.

5.5. Provision of bulk finance Provision of bulk finance against several unpaid bill.against several unpaid bill.

►BILL DISCOUNTINGBILL DISCOUNTING ►FACTORINGFACTORING

SIMILARITIESSIMILARITIES

BOTH BOTH PROVIDES PROVIDES SHORT –TERM SHORT –TERM FINANCEFINANCE..

DISCOUNT RATEDISCOUNT RATE► L/C Backed bills – 22% per annumL/C Backed bills – 22% per annum

Value = Rs10,000Value = Rs10,000 Discount charges = 10,000x0.22X90/360 = Rs550Discount charges = 10,000x0.22X90/360 = Rs550 Amount received by the client = Rs10,000 – Amount received by the client = Rs10,000 –

Rs550= Rs 9450Rs550= Rs 9450► Clean Bills – 24% per annumClean Bills – 24% per annum

Discount charges = Rs10,000x 0.24x60/360 = Discount charges = Rs10,000x 0.24x60/360 = Rs4000Rs4000

Amount received by the client =Rs10,000 – Rs 400 Amount received by the client =Rs10,000 – Rs 400 = Rs9600= Rs9600

BILL MARKET SCHEMESBILL MARKET SCHEMES►BILL MARKET SCHEME, 1952 & 1970BILL MARKET SCHEME, 1952 & 1970►RBI – effort s for full –fledged bill RBI – effort s for full –fledged bill

marketmarket Deheja Committee, 1969Deheja Committee, 1969 Tandon Committee , 1974Tandon Committee , 1974 Chore Committee, 1980Chore Committee, 1980 Vagul Committee, 1985Vagul Committee, 1985

►RBI guidelines in July 1992RBI guidelines in July 1992

IMPORTANT POINTSIMPORTANT POINTS►Advances – promissory notesAdvances – promissory notes►Rediscount – usance billsRediscount – usance bills► Credit assessmentCredit assessment►PrecautionsPrecautions

FORFAITINGFORFAITING►Forfaiting is a form of financing of Forfaiting is a form of financing of

receivables pertaining to receivables pertaining to international trade.international trade.

►All All risks and collection problemsrisks and collection problems are fully the responsibility of the are fully the responsibility of the purchaser (forfaiter) who pays cash purchaser (forfaiter) who pays cash to the seller after discounting the to the seller after discounting the bills.bills.

FORFAITING VS FORFAITING VS EXPORT FACTORINGEXPORT FACTORING

►A forfaiter, A forfaiter, discounts the entire valuediscounts the entire value of of the note/bill i.e, forfaiting is 100% financing the note/bill i.e, forfaiting is 100% financing arrangement of receivables finance but arrangement of receivables finance but factoring arrangement is only factoring arrangement is only partialpartial..

►Factoring is essentially a Factoring is essentially a short-term short-term financing dealfinancing deal. Forfaiting is . Forfaiting is long-term long-term dealdeal..

►A factor A factor does not guarddoes not guard against against exchange rate fluctuations; a forfaiter exchange rate fluctuations; a forfaiter charges a premiumcharges a premium for such risk. for such risk.

CREDIT RATINGCREDIT RATING

CREDIT RATING – CREDIT RATING – Presentation by Presentation by

SWATHISWATHI

CREDIT RATNG CREDIT RATNG ► Originated in USA – 1860, Henry vannum poor – Originated in USA – 1860, Henry vannum poor –

railroad companies(railroad companies(Standard & Poor’s)Standard & Poor’s)► Three credit rating agencies are recognized Three credit rating agencies are recognized

worldwide: worldwide: Standard & Poor’sStandard & Poor’s, Moody’s , Moody’s Investor Service(1914)(New York , 1900, John Investor Service(1914)(New York , 1900, John Moody), Fitch Ratings(Fitch publishing company – Moody), Fitch Ratings(Fitch publishing company – dec24th 1913- John knowles Fitch – New York dec24th 1913- John knowles Fitch – New York City)City)

► Standard & Poor’sStandard & Poor’s :The agency’s founding :The agency’s founding principle was “the investor has the right to principle was “the investor has the right to know”. know”. In 1966, The McGraw-Hill Companies, Inc. acquired Standard & Poor’s

Fitch’s acquired Duff & Phelps Credit Rating Co., headquartered in Chicago, in April, 2000 – New York, London

CREDIT RATINGCREDIT RATING►Credit ratingCredit rating is the is the symbolic indicatorsymbolic indicator of of

the current opinion of the rating agency the current opinion of the rating agency regarding the regarding the relative ability & relative ability & willingnesswillingness of the issuer of a financial of the issuer of a financial (debt) instrument to meet the (debt) service (debt) instrument to meet the (debt) service obligations as & when they arise.obligations as & when they arise.

CREDIT RATING AGENCY & CREDIT RATING AGENCY & RATINGRATING

CREDIT RATING AGENCY: CREDIT RATING AGENCY: A credit rating agency means a body A credit rating agency means a body

corporate engaged in the business of rating corporate engaged in the business of rating of securities offered by way of public issues.of securities offered by way of public issues.

RATING: RATING: Rating is defined as an opinion regarding

securities expressed in the form of standard symbols or in any other standardized form.

WHY CREDIT RATING?WHY CREDIT RATING?Extremely useful to………..Extremely useful to………..►Investors Investors ►Corporate (borrowers)Corporate (borrowers)►Banks & Financial institutionsBanks & Financial institutions

Debentures, bonds, secured premium notes, certificates of deposits, fixed deposits PSU bonds, preference shares,

LPG/KEROSENE dealers, chit fund, real estate developers/builders

ADVANTAGES OF CREDIT ADVANTAGES OF CREDIT RATINGRATING

►Independent evaluationIndependent evaluation►Low cost informationLow cost information►Investor protectionInvestor protection►Easily understandable symbolsEasily understandable symbols

CREDIT RATING AGENCIES IN CREDIT RATING AGENCIES IN INDIAINDIA

1.Credit rating information services of India ltd (CRISIL)1.Credit rating information services of India ltd (CRISIL)(UTI & ICICI)January 1, 1988(UTI & ICICI)January 1, 1988

2.Investment 2.Investment Information & credit rating agency of Information & credit rating agency of India (IICRA)(Public Limited Company)16India (IICRA)(Public Limited Company)16thth January January 1991(IFC,UTI,LIC,GIC,SBI & 17 banks)1991(IFC,UTI,LIC,GIC,SBI & 17 banks)

3.The credit Analysis and Research Ltd.(CARE): 3.The credit Analysis and Research Ltd.(CARE): 1993)investment companies, banks & finance 1993)investment companies, banks & finance companies)companies)

4.Phelps credit rating India Ltd. –JM Financials, Alliance 4.Phelps credit rating India Ltd. –JM Financials, Alliance Group and international agency Duffs & Phelps – Group and international agency Duffs & Phelps – 1995 – FITCH rating India Ltd.1995 – FITCH rating India Ltd.

REGULATORY FRAMEWORKREGULATORY FRAMEWORK : :CREDIT RATING AGENCIES REGULATIONSCREDIT RATING AGENCIES REGULATIONS

►Their registrationTheir registration►General obligationsGeneral obligations►Restrictions on the rating of securitiesRestrictions on the rating of securities►Procedure for inspection and Procedure for inspection and

investigation investigation ►Action in case of defaultAction in case of default

REGISTRATIONREGISTRATION►Registration with the SEBI is mandatory Registration with the SEBI is mandatory

for carrying on the rating business.for carrying on the rating business.►Promoter of credit rating agencyPromoter of credit rating agency►Eligibility criteria:Minimum Networth of Eligibility criteria:Minimum Networth of

Rs. 5 croreRs. 5 crore►Grant of certificate of registration: Initial Grant of certificate of registration: Initial

payment of Rs. 5,00,000, Renewal fee – payment of Rs. 5,00,000, Renewal fee – every 3 years Rs. 3,00,000every 3 years Rs. 3,00,000

GENERAL OBLIGATIONSGENERAL OBLIGATIONS► Code of conductCode of conduct► Agreement with the clientAgreement with the client► Monitoring of ratingsMonitoring of ratings► Procedure for review of ratingsProcedure for review of ratings► Internal proceduresInternal procedures► Disclosure of rating definitions Disclosure of rating definitions ► Submission of info to the SEBISubmission of info to the SEBI► Compliance with circulars issued by the SEBICompliance with circulars issued by the SEBI► Appointment of compliance officerAppointment of compliance officer► Maintenance of books of accounts & recordsMaintenance of books of accounts & records► ConfidentialityConfidentiality► Rating processRating process

CREDIT RATING CREDIT RATING METHODOLOGYMETHODOLOGY

► For Manufacturing companies:For Manufacturing companies: Business risk analysis: Industry risk, market Business risk analysis: Industry risk, market

position, operating efficiency, legal positionposition, operating efficiency, legal position Financial Risk analysis: Accounting quality, Financial Risk analysis: Accounting quality,

earning prospects, cash flows, flexibility, interest earning prospects, cash flows, flexibility, interest and tax sensitivityand tax sensitivity

Management risk analysisManagement risk analysis► Financial services sector:Financial services sector:

Regulatory and competitive environmentRegulatory and competitive environment Fundamental analysis: Capital adequacy, Fundamental analysis: Capital adequacy,

esources, asset quality, liquidity mgt, profitability esources, asset quality, liquidity mgt, profitability and financial position, interest and tax sensitivityand financial position, interest and tax sensitivity

RATING PROCESSRATING PROCESS1.1. New issue rating:New issue rating:

1.1. Initial contactInitial contact2.2. introductory meetingintroductory meeting3.3. Supply of dataSupply of data4.4. Rating exerciseRating exercise5.5. Analysis of new facts & enlisting new unresolved questionsAnalysis of new facts & enlisting new unresolved questions6.6. Meeting Meeting 7.7. Preparation of rating profilePreparation of rating profile8.8. Discussion & vote to determine rating.Discussion & vote to determine rating.9.9. Notification of ratingNotification of rating10.10. Issuer appeals against ratingIssuer appeals against rating11.11. formal notification formal notification 12.12. rating surveillance systemrating surveillance system

2. 2. Review of existing rating: Review of existing rating: Analysis of new data , Analysis of new data , locating possibility of rating , locating possibility of rating , credit watch notification,credit watch notification, detailed analysis meeting detailed analysis meeting

SERVICES OFFERED BY ICRA SERVICES OFFERED BY ICRA LtdLtd

►Rating servicesRating services► Information servicesInformation services►Advisory servicesAdvisory services

RATING SERVICESRATING SERVICES

► Credit AssessmentCredit Assessment► General AssessmentGeneral Assessment► Structured Finance RatingStructured Finance Rating► Claims Paying Ability Rating (CPRs)Claims Paying Ability Rating (CPRs)► Corporate Governance RatingCorporate Governance Rating► Line of credit rating Line of credit rating ► Credit assessment for small & medium scale Credit assessment for small & medium scale

industriesindustries

INFORMATION SERVICESINFORMATION SERVICES►Earnings Prospects & Risk Analysis Earnings Prospects & Risk Analysis

(EPRA)(EPRA)► Investment Information PublicationsInvestment Information Publications►Customized ResearchCustomized Research►Corporate ReportsCorporate Reports►Grading ServicesGrading Services

ADVISORY SERVICESADVISORY SERVICES►Strategic ConsultingStrategic Consulting►Risk Management AreaRisk Management Area►Regulatory PracticeRegulatory Practice►Transaction PracticesTransaction Practices►Banking & Financial ServicesBanking & Financial Services►Manufacturing & Service sectorManufacturing & Service sector►Power sectorPower sector

CONCLUSIONCONCLUSION►Default in payment of interestDefault in payment of interest►Non-banking companies – maturities Non-banking companies – maturities

more 18mths – ratedmore 18mths – rated►Rating of municipal bonds,govt Rating of municipal bonds,govt

borrowings, deposits – ratedborrowings, deposits – rated►Several constraintsSeveral constraints►Strategic alliances with international Strategic alliances with international

agencies.agencies.

REFERENCESREFERENCES►http://www.kazakhstaninvestment.com

/credit-rating-2.html►Financial services by MY KhanFinancial services by MY Khan►Emerging scenario of Financial Emerging scenario of Financial

services- Gordon & natarajanservices- Gordon & natarajan

END OF UNIT V

The following conditions :The following conditions :met to give full effect to the met to give full effect to the

factoring arrangementsfactoring arrangements1.1. The invoice, bills other documents drawn The invoice, bills other documents drawn

by the seller should by the seller should contain a clause: contain a clause: Payments arising out of the Payments arising out of the transactiontransaction as referred to or mentioned as referred to or mentioned in might be factored.in might be factored.

2.2. The seller should confirm in writing to The seller should confirm in writing to the factor that all the payments arising the factor that all the payments arising out of these out of these bills are freebills are free from any from any encumbrances, charge, lien, pledge, encumbrances, charge, lien, pledge, hypothecation or mortgage or right to hypothecation or mortgage or right to sell-off or counter-claim from another sell-off or counter-claim from another etc.’etc.’

TERMS & CONDITIONSTERMS & CONDITIONS►Selling limits for the clientSelling limits for the client►Recourse to the client in case of non-Recourse to the client in case of non-

payment by the trade customer – payment by the trade customer – conditionsconditions

►Details reg. payment for his servicesDetails reg. payment for his services► Interest to be allowed to the factorInterest to be allowed to the factor►Limit of any overdraft facility and the Limit of any overdraft facility and the

rate of interest to be chargesrate of interest to be charges

3. 3. The seller should The seller should executive a deed of executive a deed of assignmentassignment in favor of the factor to in favor of the factor to enable him to recover the payment at the enable him to recover the payment at the time or after default.time or after default.

4.The seller should confirm (by a letter of 4.The seller should confirm (by a letter of confirmation) that confirmation) that all conditions to sell-all conditions to sell-buy contractbuy contract between him and the buyer between him and the buyer have been compiled with and the have been compiled with and the transactions complete;transactions complete;

5. The seller should 5. The seller should procure a letter of procure a letter of waiverwaiver from a bank in favor of factor in from a bank in favor of factor in case the bank has a charge over the case the bank has a charge over the assets sold out to buyer and the sale assets sold out to buyer and the sale proceeds are to be deposited in the proceeds are to be deposited in the account of the bank. account of the bank.

THE BUYERTHE BUYER►Negotiates termsNegotiates terms►Receives delivery + invoice + Receives delivery + invoice +

instructioninstruction►Make payment in time/gets IN time Make payment in time/gets IN time

/ default- legal process / default- legal process

THE SELLERTHE SELLER►MOU with the buyer/agreementMOU with the buyer/agreement►80% or more payment 80% or more payment ►Balance payment after deduction Balance payment after deduction

of service charges. of service charges.

The factorThe factor►Agreement with the sellerAgreement with the seller►On receipt of copies of sale On receipt of copies of sale

document -pays 80% of the price document -pays 80% of the price of the debtof the debt

►Receives payment from buyer on Receives payment from buyer on due dates and merits the money to due dates and merits the money to seller after usual deduction;seller after usual deduction;

COST OF FACTORINGCOST OF FACTORING►Finance charge is computed on the pre-payment Finance charge is computed on the pre-payment

outstandings in your account at monthly intervals. outstandings in your account at monthly intervals. Factoring can be cheap source of funds, provided you Factoring can be cheap source of funds, provided you organize your drawals.organize your drawals.

Service/Handling charge is a nominal charge levied to Service/Handling charge is a nominal charge levied to cover the cost of services viz. collection, sales ledger cover the cost of services viz. collection, sales ledger management and periodical MIS reports. It ranges from management and periodical MIS reports. It ranges from 0.1% to 0.2% on the total value of invoices factored/ 0.1% to 0.2% on the total value of invoices factored/ collected by us. The tax payable on Service/Handling collected by us. The tax payable on Service/Handling charges is also recovered from clients.charges is also recovered from clients.