Factoring

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MFS
Chapter – 6
M. Y. KHAN
Factoring and Forfaiting
Factoring: The Concept…
• “Factor is a financial intermediary which assumes the
responsibility of collection of receivables arising out of credit
sales of their clients and in return charges commission for its
services”.
•
So, a Factor is…


A Financial Intermediary/Institute/Company
That buys invoices of a manufacturer or a trader, at a
discount, and
Takes responsibility for collection of payments.

Factoring: The Concept…
•
“Factoring
is the Sale of Book Debts by a firm
(Client) to a financial institution (Factor) on the
understanding that the Factor will pay for the Book
Debts as and when they are collected or on a
guaranteed payment date.
Normally, the Factor
makes a part payment (usually upto 80%) immediately
after the debts are purchased thereby providing
immediate liquidity to the Client”.
Factoring Services - Concept
Deliver of goods
Client
Order placed
Customer
Client submits invoice
Customer pays
Factor-Prepayment
Monthly statements
Factor
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4
Process of Factoring:
• Client makes a credit sale with a customer.
• Client sells the customer’s account to the Factor and notifies
the customer.
• Factor makes partly payment (advance) against account
purchased, after adjusting for commission and interest on the
advance.
• Factor maintains the customer’s account and follows up for
payment.
• Customer remits the amount due to the Factor.
• Factor makes the final payment to the Client when the
account is collected or on the guaranteed payment date.
Charges for Factoring Services:
• Factor charges Commission (as a flat percentage of value of
Debts purchased) (0.50% to 1.50%)
• Commission is charged up-front.
• For making immediate partly payment, interest charged.
Interest is higher than rate of interest charged on Working
Capital Finance by Banks.
• If interest is charged up-front, it is called Discount.
Functions of a Factor:
1. Administration of sales ledger
- Maintains the client’s sales ledger
- Gives periodic reports
- Current status of his receivables
- Receipts of payments from customers
- Customer-wise record of payments
- Change in payment pattern
2. Provision of collection facility
- Undertakes to collect receivables on behalf of the client
- Relieving the clients from problems involved in collection
- Enables the clients to reduce cost of collection
Functions of a Factor: CONT…
3. Financing Trade Debts:
4. Credit Control And Credit Protection:
- This service is provided where debts are factored without
recourse. Factor assumes the risk of default.
5. Advisory Services:
- Specialized knowledge and experience
- Customers’ perception
- Change in marketing strategies
- Emerging trends
Types / Forms of Factoring:
1. Recourse Factoring:
 Factor does not assume credit risks associated with
receivables.
 Credit Risk is borne by the Client.
 In India, Factoring is done with recourse.
2. Non-Recourse Factoring:
 Factor assumes credit risks associated with receivables.
Charges a higher commission
 Credit risk is assumed by Factor
 In USA/UK, Factoring is commonly done without recourse.
Types / Forms of Factoring:
3. Advance Factoring:
 Factor pays a specified portion (75% to 90%) in advance.
 Balance being paid upon collection from the customer. The
client has to pay interest on advance payment.
Example of Advance Factoring Mechanism:
2
Client
Assigns invoice
4 monthly statement of accounts
Factor
5 payment to factor
1
Credit sale
Customer
Types / Forms of Factoring: CONT…
4. Maturity Factoring / Collection Factoring:
 Factor does not make any advance payment to the Client.
 Factor Pays on date of collection/agreed future date.
 Less RISK for Factor and charges nominal commission.
5. Full Factoring / Old Line Factoring:
 Features of almost all the factoring services.
 Entire spectrum of services; collection, credit protection, sales
ledger administration, short-term finance.
Types / Forms of Factoring: CONT…
6. Disclosed Factoring:
 Name of factor is disclosed in sales invoice.
7. Undisclosed Factoring:

Name of factor is NOT disclosed in sales invoice.
8. Domestic Factoring:

Buyer, Seller, Factor domiciled in the same country.
Types / Forms of Factoring: CONT…
9. Export / Cross Border / International Factoring:
 Usually Four Parties Involved Viz. the Exporter, Importer,
Export Factor, Import Factor.
 Two Agreements.
 Import Factor Provides Link Between Export Factor and
Importer.
 Import factor underwrites customer trade credit risk, collects
receivables and transfers fund to export factor.
International Factoring Transactions:
Receives order
Credit limit request
Approval
Delivers goods
Submits documents
P repayment
Documents
Collection
P ayment remittance
Balance payment
1
Exporter
3
4
Importer
6
8
7
2
5
10
Export Factor
9
Import Factor
International Factoring Transactions
Advantages of Factoring:
1. Off-balance Sheet Finance
2. Reduction of Current Liabilities
3. Improvement in Current Ratio
4. Higher Credit Standing:
5. More time for Planning and Production
6. Reduction of Cost and Expenses
7. Additional Source of Finance
WHY FACTORING HAS NOT BECOME POPULAR IN INDIA?
• Banks’ unwillingness to provide factoring services
• Problems in recovery.
• Factoring requires assignment of debt which attracts Stamp
Duty.
• Cost of transaction becomes high.
• Lack of awareness.
Factoring in INDIA: Major Players
•
•
•
•
•
•
•
•
•
SBI Factors and Commercial Services Pvt. Ltd.
Canbank Factors Limited
Global Trade Finance Limited
Foremost Factors Limited
HSBC Bank
CITI Bank NA, India
Standard Chartered Bank
SIDBI
ECGC Ltd.
FORFAITING: THE CONCEPT
- “Forfeiting refers to financing of receivables pertaining to
international trade”.
- Forfaiting is a mechanism by which the right for export
receivables of an exporter (Client) is purchased by a Financial
Intermediary (Forfaiter) without recourse to him.
- Converts exporter’s credit sale into cash sale.
- Discounting the documents covering the entire risk of nonpayment in collection.
- Credit period can range from 3 to 5 years.
2
Exporter
1
6
7
Importer
3
5
Forfaiting
Transactions
4
9
8
Forfaiter
1.
2.
3.
4.
5.
10
Committed to purchase debt
Commercial contact
Delivery of goods
Gives guarantee
Hands over documents
Avalling Bank
6. Delivers documents
7. Makes payment
8. Presents document for payment
9. Repays at maturity
10.Payment to the forfaiter
Characteristics of Forfaiting:
• Converts Deferred Payment Exports into cash transactions,
providing liquidity and cash flow to Exporter.
• Discharge Exporter from Cross-border Political OR Exchange
Risk associated with Export Receivables.
• Finance available upto 100% (as against 75 - 80% under
conventional credit) without recourse.
• Acts as additional source of funding and hence does not have
impact on Exporter’s borrowing limits. It does not reflect as
debt in Exporter’s Balance Sheet.
• Provides Fixed Rate Finance and hence risk of interest rate
fluctuation does not arise.
Characteristics of Forfaiting: Cont…
• Exporter is freed from credit administration.
• Simple Documentation as finance is available against bills.
• Forfait financer is responsible for each of the Exporter’s trade
transactions. Hence, Export business can be done more
efficiently.
• Forfait transactions are confidential.
FORFAITER’S CHARGES
• The DISCOUNT charged by the Forfaiter depends upon:
Cost of Forfaiting
Margin to cover risk
Management charges
Fees for delayed payment
Period of Forfaiting contract
Credit rating of Avalling Bank
Country/Currency Risk of the importer
Export Factoring V/s Forfeiting:
Sr.
No.
Export Factoring
Forfaiting
1
75 to 90% Financing
100% Financing
2
Financing, Collection, Sales
Ledger Administration
Pure Financing
3
Short Term Financing
3 To 5 Years
4
Does not guard against
Exchange Rate Fluctuation
Forfaiter guards.
FACTORING vs. FORFAITING
POINTS OF
DIFFERENCE
Extent of Finance
FACTORING
Usually 75 – 80% of the
value of the invoice
Credit Worthiness Factor does the credit
rating in case of nonrecourse factoring
transaction
FORFAITING
100% of Invoice value
The Forfaiting Bank
relies on the
creditability of the
Availing Bank
Services provided Day-to-day
No services are
administration of sales
provided
and other allied/advisory
services
FACTORING vs. FORFAITING – CONT…
POINTS OF
DIFFERENCE
FACTORING
FORFAITING
Recourse
With or without recourse Always without
recourse
Size of
transaction
Usually no restriction on
minimum size of
transactions that can be
covered by factoring.
Scope of service Service is available for
domestic and export
receivables.
Transactions should be
of a minimum value of
USD 250,000.
Usually available for
export receivables only
denominated in any
freely convertible
foreign currency.
WHY FORFAITING HAS NOT DEVELOPED…
• Relatively new concept in India.
• High Rupee Fluctuation
• High cost of funds
• High minimum cost of transactions (USD 250,000/-)
• RBI Guidelines are unclear.
• Very few institutions offer such services in India. Exim Bank
is one of the major player and very few other co’s involved.
• Lack of awareness.
List of some Forfaiters:
• Standard Bank, London
• Hong Kong Bank
• ABN AMRO Bank
• Meghraj Financial Services
• Triumph International Finance India Ltd.,
• Natwest Bank
• Meridian Finance Group
4/13/2015
28
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