First we talk about factoring.What is factoring?Factoring as a fund based financial service,provides resources to finance receivables as well as facilitates the collection of receivables.
Factoring concept and mechanism
Concept-In the absence of any uniform codified law,the term”factoring” has been defined in various countries in different ways.Many efforts of service have been made to arrive at consensus regarding uniform meaning and defining a well laid scope for such a type contract.
Factoring means an arrangement between a factor and his client which include at last two of the following services to be provided by the factor.
(ii)Maintenance of accounts
(iii)Collection of debt
(iv)Protection against credit risk
Mechanism of factoring
Credit sales generate the factoring business in ordinary course of business dealings. Realisation of credit sales is the main function of factoring service.Once sale transaction is completed ,the factor step into realise the sales.Thus factor works between the seller and the buyer and sometimes with seller’s bank together.
Types of factoring
The collection of receivables and saler ledger administration is a common features of practically all factoring transaction.The important form of factoring arrangements are briefly discussed below.
1)Recourse and non-recourse factoring -A recourse factoring arrangements when the factor does not assume credit risk associated with the receivables.If the customer default in payment the client has to make good the loss incurred by the factor charges the client for maintaining the sales ledger and debt collection services and also for the interest for the period on the amount drawn by the client .
2)Advance and maturity factoring -The factor pays a pre-specified portion between three-fourth to nine-tenth of the factored receivables in advance,the balance being paid upon collection on the guaranteed payment date.A drawing limit ,as a pre-payment is made available by the factor to the client as soon as factored debts are approved.
Bank participation factoring under which a bank provides advance given by the factors.A maturity factoring is also knowns as collection factoring under such arrangement,the factor does not make a pre payment to the client.The payment is made either or the guaranteed payment date or on the date of collect ion.
3)Full factoring-This is the most comprehensive form of factoring combine the features of almost all the factoring services specially those of non-recourse and advance factoring.
4)Disclosed and undisclosed factoring-In disclosed factoring the name of the factor is disclosed in the invoice by the supplier-manufacturer of the goods asking the buyer to make payment to the factor .The supplier may continue to bear the risk of non-payment by the buyer without passing it on to the factor.
Function of factor
1)Administration of ledger-The factor maintains the clients sales ledger.On transacting a sales deal.The customer is account closely.reflects the various open invoices outstanding on any given date
2)Provision of collection facility-The factor under takes to collect the receivables on behalf of the problem involved in collection and enables him to concentrate on other important functional areas of the business.The use of trained manpower with sophisticated infrastructural back up enables ,a factor to systematically follow up and make timely demos on the debetors to make payments.
3)Financing trade debts-The unique feature of factoring is that a factor purchase the book debts of his client at a price and the debts are assigned in favor of the factor who is currently willing to grant advance to the extent of 80-85 percent of the assignment debts where the debts are factored with recourse the finance provided would become refundable by the client in case of non-payment by the buyer.
4)Credit control and credit protection-Assumption of credit risk is one of the important functions of a factor without recourse .The factor in consultation with the client fixes credit limits for approved customer.The factor undertakes to purchase all trade debts of the customer without recourse.In other words the factor assumes the risk of default in payment by customers.
Forfaiting is a form of financing of receivables pertaining to international trade .It denotes the purchase of trade bills/promising notes by a bank financial institution without recourse to the seller.The purchase is in the form of discounting the documents covering the entire risk of non-payment in collection problem are fully the responsibility of the purchaser(forfaiter) who pays cash to seller after discounting the bill/notes.