Factoring (also known as receivables factoring & debtor financing), is a form of financial transaction in which a company (known as a factor) buys a debt or invoice from another company. In factoring, accounts receivable are discounted in order to allow the buyer to make a profit upon the settlement of the debt. This allows the company that has sold its debts (receivables) access to "realised sales" after paying the discounted premium and thereby improving cash flows and reducing credit exposure on their buyers.
Factoring is a provision for short-term finance, rapid financing of receivables, incorporating risk prevention, follow-up and account management. Factoring provides an alternate means of financing, which helps reduce the overall credit risk of the client. It also reduces the requirements and efforts in receivables management (in terms of follow up, reminders etc)
Depending upon the requirments of individual clients, a company may use factoring In Start-up/ rapid growth Phase: To Overcome the shortfall of cash flow or bank credit limits, financing receivables through a factor is advantageous. In normal growth Phase: A company gets protection against credit risk in customer payments.
Most factoring transactions are structured in a manner that factoring facility is 'without recourse' in case of financial credit risk. This allows the sale to be treated as complete and therefore, factoring is sought after by many corporates as it helps in sales realisation and balance sheet improvement.
Additionally, given that the factor is taking the 'buyer risk', most factoring structures are 'without recourse' to the client (which has factored its receivables).
There are two-three main components upon which factor's services are remunerated as: The Factoring facility fees: This is for setting up the factoring facility. The Financing rate: This is the rate at which the invoices are discounted Factoring fees: This is the rate for extending factoring for specific buyers. Generally speaking, this is fee for arranging limits on a specific buyer.
Factoring & bill discounting are used to fulfil the requirements of short-term financial requirements of a company. Bill discounting is the advance against the bill and is a with-recourse facility therefore will require collateral, whereas factoring is generally 'without recourse' and doesn't require any collateral.
The factor usually purchases the accounts receivables of the company. They take direct exposure on the buyer and for this risk, they enjoy higher discounting rate than normal transactions. In addition, the advance ratio (the % of the invoice that is financed) ranges between 80-90% of the invoice value, therefore keeping the seller of receivables still interested in getting the full realisation done.
The invoices of the company are purchased by the factoring company in two instalments. About 80% of the receivables are advanced in the 1st instalment & the remaining 20% is advanced (net of charges) as soon as the buyer pays the invoice in full.
In Non-Recourse factoring, the factor covers the financial credit risk of the client. Therefore, in the event of a credit default on payment by the client's customer, the loss is on account of the factor. Performance risk such as quality issues, trade disputes are never covered by the factor. Only credit risk is covered.
It is the agreement under which the terms and conditions of the factoring programme are defined and agreed upon. It lays down the purchase of receivables, procedures, addition of buyers, representation & warranties of each party, default triggers, responsibilities of each party and dispute settlement mechanism etc. between the factor and the client.
No, in most cases it doesn't matter to a large extent. Whenever a company opts to avail invoice factoring, all it has to worry about is how fast it can submit the invoice with the agency and the credit quality of the buyers. The Factors basically look mainly at the creditworthiness of company's clients (i.e. their buyers). Once the client of the company is authenticated and approved, the factor will be start the purchase of receivables of that particular buyer.
The main differences between Factoring and forfaiting are as follows:
1. Forfaiting is only used in International trade finance whereas factoring is used in both domestic & international trade.
2. Letter of Credit (LC) is not used in factoring but it is a part of forfaiting.
3. Factoring deals with accounts receivables whereas forfaiting deals with negotiable instruments.
Yes, Indian exporters can avail factoring services from foreign companies instead of banks as per FEMA regulations. A copy of factoring agreement will be required by the bank to be submitted to them for reporting and monitoring purposes.
There are two ways for the exporter to handle this situation:
1. If the buyer rejects the shipment in full, the exporter needs to refund the advance to the factoring company. You may now dispose of the shipment, as per your arrangement with the buyer.
2. In case the buyer asks for discount, it is to be borne by the exporter. The Factoring company will recover any short payments, if required.
No, your buyer needs to make payment of all invoices to the factoring company. Very rarely, the factor may allow the client to become the factor's collection agent and receive payments directly from the buyer, but in such cases, the client is legally bound to remit it to the factor as they are acting as their agent.
Companies having B2B (business-to-business) model that invoices their clients are eligible for availing services of a factoring company. There are various companies that often use invoice financing like, transportation, manufacturing, wholesale, trucking and oil & gas businesses.
Some of the considerations that factors like to consider before agreeing to provide factoring facility are:-
a. Who is the Buyer? -- Good quality buyers are considered.
b. What is your export volume? -- Regular transactions are required.
c. Since how long you have been exporting to your party? -- At least 2 years of continuous export is required.
d. How many shipments have you completed so far? -- Around 10-20 realised shipments are required.
e. After shipment, what is your credit period that you extend to your buyer? -- This is the period of discounting / funding. Very short tenors or very long tenors are not considered.
f. What goods do you export? -- Certain items like gems / jewellery / perishable items are prohibited.
g. How're you exporting? -- Is it direct documents (exporter sends directly to its importer) OR do you send the documents through banking channel (the exporter submits documents to its own bank which in turn send the documents on collection basis) -- The procedure is slightly different in each case.
h. Is it a consignment sale? -- Consignment sale is where goods are sent to an agent of the company and then he sells later. This is not eligible for Factoring as there is no immediate sale.
i. The buyer is an end user or there is a broker or a trader or buying house involved in between? -- Only exports to end user are considered.
j. Where is your buyer based? -- Remote countries are not considered
1. Factoring will not be extended in related part transactions, therefore your Indian parent will not be able to factor receivables from your US subsidiary.
2. Factoring can be extended to the US subsidiary for sales to other unrelated US corporations.