Factoring & Forfaiting

FACTORING
&
FORFAITING
INTRODUCTION
• Leasing , HP & consumer credit are all fund based financial
services predicated upon Fixed Assets of the firm
• While factoring is predicated on receivables
• Can Bank factors limited is leading player with 55 % share while

SBI Factors & commercial services limited has a market share of
40%
• Factoring is sale of book debts by a firm “client” to financial

intermediary “factor” that he will pay for the debt as & when
they are collected or on a guaranteed payment date but a part
usually immediately to provide the liquidity to client
• Collection of receivables & maintenance of sales ledger

PRACTICAL PROBLEM
• SBI Factors advances Rs 14 lacs to ABC ltd against

agreement of providing advance payment of 80 % of
receivables & for guaranteed payment after 3 months. The
rate of interest is 16 % compounded quarterly & factoring
commission is 1.5 % of receivables. Both collected upfront
• Compute amount actually made available to ABC ltd
• Calculate effective cost of funds made available to ABC
• Assume interest is collected in arrear & commission in

advance what would be effective cost of funds
SOLUTION
• A)
• Value of factored receivable 14/0.8 17.50
• Max advance 14.00
• Less commission 17.5 * 0.015 0.26
13.74
• Less interest 14 * 0.16 * 90/360) 0.56
• Funds made available to ABC 13.18
• B)
• Effective Interest as % of funds 0.56 / 13.18 *100 4.25%
( per quarter)
• Annualised rate of interest = [( 1 + i ) p – 1] * 100
• Annualised rate of interest [ ( 1.0425) 4 – 1 ] *100 18.11%
SOLUTION
• C)
• Max permissible finance 14.00

• Less commission 0.26
• Funds available 13.74
• Interest 14 * 0.16 * 90 / 360 ) 0.56
• Effective Interest as % of funds 0.56 / 13.74 *100 4.08%
• Annualised rate of interest [ ( 1.0408) 4 – 1 ] *100 17.35%

FORMS OF FACTORING
• Recourse
– The factor has recourse over the client if debts become

irrecoverable
– Loss on irrecoverable debts is to be borne by client
• Non recourse
– Factor has no recourse to the client for irrecoverable debts
– Extra commission “del credere “ is charged
– Common on USA,UK but not in India

FORMS OF FACTORING
• Maturity factoring
– Factor does not make any advance payment
– Factor pays either on guaranteed date or on date of collection
– Factor charges commission
• Advance factoring
– Factor provides advance to client between 75-85 % of receivables
– Rest amount is held & known as “Factor Reserve”
– Factor charges commission & interest on advance too
FORMS OF FACTORING
• Bill / Invoice Discounting - Both factoring & bill discounting
make available finance against receivables but they are different
Transaction oriented & each bill is Pre payment against all unpaid &
separately discounted non due invoices
No responsibility of sales ledger Factor is responsible for both
maintenance & collection of debts collection & maintenance of sales
ledger
No notice of assignment is In factoring notice of assignment is
provided to customer of client provided to customer of client
With recourse to client May or may be Non recourse
Bills can be rediscounted several Factor cannot rediscount the

times. Last holder of bills receives receivables
full value of bills
FORMS OF FACTORING
• Bill / Invoice Discounting
– Strictly it is not factoring as there is no sales ledger administration &
collection of Debts
– The facility of Bill discounting is kept confidential from customers
of client
– Hence referred as “Confidential factoring”
– Variant --- When factor bears risk of Bad debts (Non Recourse), it is
called as “Protected Invoice Discounting”
– If invoice discounting is not kept confidential then it is called as

“Bulk Factoring”
– Variant ---When factor bears risk of Bad debts (Non -Recourse), it is

called as “Agency Factoring”
FORMS OF FACTORING
• Full factoring
– Factoring arrangement which combines Advance factoring &
Non recourse
– It is also called as Old Line factoring
– Considers collection , sales ledger administration & short
term finance having Non recourse features
• Bank Participation Factoring

– Extension of Advance factoring
– Financing the Factor Reserve too by Bank
– Commercial Bank participates by providing an advance to
client against the reserves maintained by factor
FORMS OF FACTORING
• Supplier Guarantee Factoring
– Customer places order with Importer/Distributor
– Importer/distributor seeks approval of his factor for
extending credit to customers
– On getting approval, Importer/Distributor makes
arrangement of shipping of supplies from supplier to
customer
– Factor guarantees payment directly to supplier on
behalf of client ( Importer/Distributor)
– Instead making advance to Importer/Distributor , the Factor
directly makes payment to Supplier
– Builds greater confidence between Supplier- Importer /
Distributor relationship
FORMS OF FACTORING
• Cross Border Factoring
• Also called as International or export factoring
• Four parties-Exporter, Export factor ,Importer & Import Factor
– Exporter enters into agreement with Export factor domiciled in his

country & assigns him export receivables
– Export factor enters into arrangement with Import factor & contracts
out task of sales ledger maintenance & collection
– Import Factor collects amount from Importer & remits it to Export

Factor who gives it to Exporter
FACTORING / CREDIT INSURANCE
• Factoring
– involves sales ledger maintenance & collection
• Credit Insurance
– Insurance company merely settles down the claim arising on
account of insured account which have turned delinquent
(not exactly insolvent but overdue also)
– Insurance company specifies the maximum amount it will
cover on basis of credit rating
– Ex Dun & Bradstreet does credit rating for this purpose in
US
FORFAITING
• Common form of financing export related receivables
• Exporter sells goods to importer on deferred payment of 3-5 years
• Importer draws a series of promissory notes inclusive of interest
• These notes are avalled by Importer’s Banker ( endorsement by
Importer’s Banker in case of default)
• Exporter sells these avalled noted to forfaiter & gets 100 % finance
• Forfaiter holds these notes till maturity or sell it to group of investors
(secondary market)
• Forfaiter do not give other services like collection or sales ledger
maintenance
FACTORING FORFAITING
• Usually 80 % is financed 100% financing
• Factor credit rates the counter- Forfaiting Bank relies on

party in Non recourse cases avalling Bank
• Administration of sales ledger No such services
• Advances for short term medium term advances

FUNCTIONS OF FACTOR
• Collection
– Sends statement of account to customers prior to &
collection letters around due dates
– Initiates personal collection efforts by personal letter,
telephonic contact & visiting premises when debts become
overdue
– Legal action if debt is irrecoverable
• Sales ledger administration
– Balancing method
• Transaction are recorder in chronological order
• Net amount carried forward
– Open item method
• Each receipt is matched with each invoice
FUNCTIONS OF FACTOR
• Credit protection
– In Non recourse factoring , the factor defines credit limit up to
which client can sell to customer
– Factor relies on
• Credit rating of customer
• Bank reports of customer
• Analysis of financial statements of customer
– Current ratio
– Quick ratio
– NP margin
– ROI
• Prior collection experiences with customers
• Customer premises visits
FUNCTIONS OF FACTOR
• Short term funding
– Factor finances usually 80 % keeping factor
reserve(20%) for sales returns & disputed Debts
• Advisory services
– Advises client on customer’s perception of firm’s
product as Factor has expertise of client’s market
– Changes called in marketing strategies
– Emerging trends & how to respond them
– Audit of procedures followed for invoicing, delivery &
dealing with sales returns
– Provides introduction of factor with Bank of which
Factor is subsidiary for other financial services
FACTORING MASTER AGREEMENT
(LEGAL ASPECTS)
• Client gives undertaking to sell all receivables
• Client warranties that debts are valid, enforceable, undisputed &
recoverable
• In Non Recourse factoring , bills approved falls within credit
limits authorised by factor
• Client agrees to serve notice of assignment to customers
• Client agrees to provide copies of invoices & credit notes to
factor
• Factor acquires POA to assign receivables further
• Time frame & termination of agreement
• Customer is notified that he has to remit money to factor
• Letter of disclaimer from Banker of factor that the same has not
discounted bills to avoid double financing

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FACTORING

• Can Bank factors limited is leading player with 55 % share while

• Factoring is sale of book debts by a firm “client” to financial

• Collection of receivables & maintenance of sales ledger

• SBI Factors advances Rs 14 lacs to ABC ltd against

• Compute amount actually made available to ABC ltd

• Calculate effective cost of funds made available to ABC

• Assume interest is collected in arrear & commission in

• Max permissible finance 14.00

• Effective Interest as % of funds 0.56 / 13.74 *100 4.08%

• Annualised rate of interest [ ( 1.0408) 4 – 1 ] *100 17.35%

– The factor has recourse over the client if debts become

– Factor has no recourse to the client for irrecoverable debts

– Extra commission “del credere “ is charged

– Common on USA,UK but not in India

Bills can be rediscounted several Factor cannot rediscount the

– If invoice discounting is not kept confidential then it is called as

– Variant ---When factor bears risk of Bad debts (Non -Recourse), it is

• Bank Participation Factoring

• Four parties-Exporter, Export factor ,Importer & Import Factor

– Exporter enters into agreement with Export factor domiciled in his

– Import Factor collects amount from Importer & remits it to Export

• Factor credit rates the counter- Forfaiting Bank relies on

• Administration of sales ledger No such services

• Advances for short term medium term advances

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