Internal Guide:-Submitted By
Internal Guide:-Submitted By
Submitted by:-
Mrs K.K.Acharya Reeturani Bohidar
Sr.Finance Faculty MBA 6th Trimester
Roll no.-B/07/02
FACTORING
INTRODUCTION
Factoring is a type of financial service provided by the specialist
organizations. When small scale firms sell on credit basis, collection of receivable
poses a problem. In that case factoring organizations play an important role in
collection of debtors. Factoring involves sale of receivables to specialized firm,
called factors. Factors collect receivables and also advance cash against
receivables to solve the client firm’s liquidity problem. For providing their
services, they charge interest on advance and commission for other services. In
other words, factoring is an arrangement under which a financial institution (called
factor) undertakes the task of collecting the book debts of its client in return for a
service charge in the form of discount or rebate. The factoring institution
eliminates the client’s risk of bad debts by taking over the responsibility of book
debts due to the client. The factoring institution advances a proportion of the value
of book debts of the client immediately and the balance on maturity of book debts.
DEFINITION
“Factoring is a service involving the purchase by a financial organization,
called a factor, of receivables owned to manufacturer and distributors by their
customers, with the factor assuming full credit and collection responsibilities.”
“Factoring is a service of financial nature involving the conversion of credit
bills into cash.”
Characteristics of factoring
1. Usually the period for factoring is 90 to 150 days. Some factoring companies
allow even more than 150 days.
2. Factoring is considered to be a costly source of finance compared to other
sources of short term borrowings.
3. Factoring receivables is an ideal financial solution for new and emerging
firms without strong financials. This is because credit worthiness is evaluated
based on the financial strength of the customer (debtor). Hence these
companies can leverage on the financial strength of their customers.
4. Bad debts will not be considered for factoring.
5. Credit rating is not mandatory. But the factoring companies usually carry out
credit risk analysis before entering into the agreement.
6. Factoring is a method of off balance sheet financing.
7. Cost of factoring=finance cost + operating cost. Factoring cost vary according
to the transaction size, financial strength of the customer etc. The cost of
factoring varies from 1.5% to 3% per month depending upon the financial
strength of the client's customer.
8. Indian firms offer factoring for invoices as low as 1000Rs
9. For delayed payments beyond the approved credit period, penal charge of
around 1-2% per month over and above the normal cost is charged (it varies
like 1% for the first month and 2% afterwards).
MECHANISM
A factor provides finance to his client upto a certain percentage of the
unpaid invoices which represent the sales of goods or services to approved
customers. The mechanism of the factoring scheme is as follows:
There should be a factoring arrangement (invoice purchasing arrangement)
between the client(which sells the goods and services to trade customer in
credit) and the factor, which is the financing organization.
Whenever the client sells goods to the trade customers on credit he prepares
invoices in the usual way.
The goods are sent to the buyers without raising a bill of exchange but
accompanied by an invoice.
The debt due by the purchaser to the client is assigned to the factor by
advising the trade customers to pay the amount due to the client, to the
factor.
The client hands over the invoices to the factor under cover of a schedule of
offer along with the copies of invoices and receipted delivery challans.
The factor makes an immediate payment upto 80% of the assigned invoices
and the balance 20% will be paid on realization of the debt.
credit sale of
goods
Customer Client
Invoice
Pays the
Pays the amount (In recourse balance
type customer pays through amount Submit invoice
client) copy
Payment up to
80% initially
Factor
TYPES OF FACTORING
ADVANTAGES
Benefits of Factoring to Clients
1) Under the factoring arrangement the client receives prepayment upto 80-90
percent of the invoice value immediately and the balance amount after the
maturity period. This helps the client to improve cash flow position which
enables him to have better flexibility in managing working capital funds in
an efficient and effective manner.
2) If the client avails the services of the factor in respect of sales ledger
administration and collection of receivables, he need not have any
administrative set up for this purpose. Naturally this will result into a
substantial saving in time and cost of maintaining own sales ledger
administration and collecting receivables from the customer. Thus, it will
reduce administrative cost and time.
3) When without recourse factoring arrangement is made, the client can
eliminate the losses on account of bad debts. This will help him to
concentrate more on maximizing production and sales. Thus, it will result in
increase in sales, increase in business and increase in profit.
4) The client can avail advisory services from the factor by virtue of his
expertise and experience in the areas of finance and marketing. This will
help the client to improve efficiency and productivity of his organization.
Besides this, with the help of data base, the factor can readily provide
information regarding product design/mix, prices, market conditions etc., to
the client which could be useful to him for business decisions.
The above mentioned benefits will accrue to the client provided he develops a
better business relationship with the factor and both of them have mutual trust in
each other.
Disadvantages of Factoring
1) Image of the client may suffer as engaging a factoring agency is not considered
a good sign of efficient management.
2) Factoring may not be of much use where companies or agents have one time
sales with the customers.
3) Factoring increases cost of finance and thus cost of running the business.
4) If the client has cheaper means of finance and credit (where goods are sold
against advance payment), factoring may not be useful.
CASE STUDY OF SUNLIGHT INDUSTRIES LTD.
Sunlight industries ltd. manages its account receivables by its sales and
credit department. The cost of sales ledger administration stands at Rs 9 crore
annually. It supplies chemicals to heavy industries. These chemicals are used as
raw material for further use or are directly sold to industrial units for consumption.
There is a good demand for both the types of uses. For the direct consumers, the
company has a credit policy 2/10, net 30. Past experience of the company has been
that on avg. 40% of the customer avail of the discount while the balance of the
receivables are collected on an avg. 75 days after the invoice date. Sunlight
industries also has small dealer networks that shall the chemicals bad debt of the
company are currently 1.5% of total sales.
Sunlight industries finances its investment in debtors through a mix of bank
credit and own long term funds in the ratio of 60:40 current cost of bank credit and
long term funds are 12% and 15% respectively.
There has been a consistent rise in the sales of company due to its proactive
measures in cost reduction and maintaining good relations with dealers and
customers. The projected sales for the next year are Rs 800 crore of 50% from last
year. Gross profits have been maintain at a healthy 22% over the years and are
expected to continue in futures.
With escalating cost associated with the in-house management of debtors
coupled with the need to unburden the management with the task so as to focus on
sales promotion, the CEO of Sunlight Industry examine the possibility of
outsourcing its factoring service for managing its receivables. He assigns the
responsibility to Anita Guha, the CFO of Sunlight. Two proposals the details of
which are given below are available for Anita’s consideration.
Proposal from Canbank Factors Ltd.: The main element of the proposal are :
i. Guaranteed payment within 30 days
ii. Advance, 88% and 84% for the recourse and non-recourse arrangement
respectively
iii. Discount charge in advance 21% for recourse and 22% without recourse
iv. Commission, 4.5% without recourse and 2.5% with recourse
The opinion of the chief Marketing manager is that in context of the factoring
arrangement his staff would be able to exclusively focus on sales promotion which
would result on additional sales of Rs 75 crore.
CONCLUSION
Factoring is a money market instrument.
Since, factoring is not a negotiable instrument, customer’s consent is
required about the factoring arrangement under which he will make a
repayment directly to the factor but not to the client.
As a result of factoring services, the enterprise can concentrate on
manufacturing and selling.
The risk of bad debts is eliminated.
The factoring institution also provides advice on business trends and other
related matters.