Factoring

Meaning
 Also referred as “Invoice Discounting”
 The business unit sells its bill receivables to a third party at a discount in order to raise
funds.
 It helps companies with cash flow problems due to slow-paying clients.

What is a Factoring Company?

 A factoring company specializes in invoice financing for small to medium businesses that
are non-bankable

FACTORING PROCESS / FACTORING MECHANISM / HOW DOES INVOICE FACTORING WORK?

1. Your company delivers the goods/services to your client.
2. You submit an invoice for financing
3. The factoring company advances 80% of the invoice (this amount varies)
4. Your client pays after 30 to 90 days
5. The factoring company issues a rebate of 20%, less the finance fee.

 The seller makes the sale of goods or services and generates invoices for the same.
 The business then sells all its invoices to a third party called the factor.
 The factor pays the seller, after deducting some discount on the invoice value.
 The rate of discount in factoring ranges from 2 to 6 percent.
 However, the factor does not make the payment of all invoices immediately to the seller.
Rather, it pays only up to 75 to 80 percent of invoice value after deducting the discount.
 The remaining 20 to 25 percent of the invoice value is paid after the factor receives the
payments from the seller’s customers. It is called factor reserve.
 FUNCTIONS OF FACTOR
1. Maintenance Of Sales Ledger
 A factor is responsible for maintaining the sales ledger of the client. So the factor takes
care of all the sales transactions of the client.
2. Financing
 The factor finances the client by purchasing all the account receivables.
3. Credit Protection
 In the case of non-recourse factoring, the risk of non-payment or bad debts is on the
factor.
4. Collection Of Money
 The factor performs the duty of collecting funds from the client’s debtors. This enables the
client to focus on core areas of business instead of putting energies in the collection of
money.

TYPES OF FACTORING
1. Recourse Factoring - the credit risk remains with the client though the debt is assigned to the factor
2. Non-Recourse Factoring - also called as ‘Old-line factoring’ and the risk of bad debt is absorbed by
the factor.
3. Advance Factoring - Where the payment is made by the factor immediately
4. Confidential and Undisclosed Factoring - the arrangement between the factor and the client are
left un-notified to the customers
5. Maturity Factoring - the factor may agree to pay an amount to the client for the bills purchased by
him either immediately or on maturity
6. Supplier Guarantee Factoring - also known as ‘drop shipment factoring’ and this happens when the
client is a mediator between supplier and customer
7. Bank Participation Factoring - the amount payable by the factor to the client in .respect of his
receivables

Major Players
1. Banks
2. Hire purchase financier
3. Leasing companies
4. Factoring
5. Underwriters and merchant bankers
6. Book-builders
7. Mutual funds
8. Credit rating companies
9. Housing finance companies
10. Asset liability Management Company
11. Finance companies
 OPERATIONAL PROBLEMS IN FACTORING IN INDIA
Introduction
 The factoring service in India is at a growing stage.
 Its quantitative growth is relatively limited.
 Its future depends on the removal of a number of real operational difficulties.

OPERATIONAL PROBLEMS IN
FACTORING

Credit Legal Disclaimer Limited

Stamp Duty Funding
Information Framework Certificate Coverage

1. Credit Information
 The factors do not have access to any authentic common sources of information. They
have to depend on their own data-base for credit evaluation of clients.
2. Stamp Duty
 The assignment of debt attracts stamp duty charged by the government which is as high
as 15 per cent on the amount exceeding Rs 2 lakh.
3. Legal Framework
 Changes are also called for in other components of the present legal framework to ensure
success of factoring in India.
4. Funding
 The factors in India are not allowed access to wider funding sources on scales available to
other finance companies.
5. Disclaimer Certificate
 To purchase a book debt of its clients, a factor needs disclaimer certificate from banks. In
the present context they are unwilling to issue such a certificate.
6. Limited Coverage
 At present only domestic factoring of the advance with recourse is permitted and offered
in India.
 FACTORING VS BILLS DISCOUNTING / DIFFERENCE BETWEEN BILL
DISCOUNTING AND FACTORING

BASIS FOR
BILL DISCOUNTING FACTORING
COMPARISON

Process of trading or selling Is a transaction in which the client

Meaning the bill of exchange to the or borrower sells its book debts
bank or financial institution to the factor at a discount

The entire bill is discounted

Arrangement and paid, when the transaction Follows 80:20 principles
takes place.

Parties Drawer, Drawee and Payee Factor, Debtor and Client

Type Recourse only Recourse and Non Recourse

The Negotiable Instrument

Governing statute No such specific act.
Act, 1881

Financier gets interest for

Discounting Charges or financial services and
Financier's Income
interest commission for other allied
services.

Assignment of
No Yes
Debts