Factoring and forfaiting

What is factoring?

Factoring is a financial option for the management of receivables. In simple definition it is the conversion of credit sales into cash. In factoring, a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80%(rarely up to 90%) of the amount immediately on agreement.

Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when the customer pays the debt. Collection of debt from the customer is done either by the factor or the client depending upon the type of factoring.



The account receivable in factoring can either be for a product or service.

Examples are factoring against goods purchased, factoring for construction services (usually for government contracts where the government body is capable of paying back the debt in the stipulated period of factoring.



Characteristics of factoring



Usually the period for factoring is 90 to 150 days. Some factoring companies allow even more than 150 days.

Factoring is considered to be a costly source of finance compared to other sources of short term borrowings.

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.

Bad debts will not be considered for factoring.



Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement.

Factoring is a method of off balance sheet financing.

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 vary from 1.5% to 3% per month depending upon the financial strength of the client's customer.

Indian firms offer factoring for invoices as low as 1000Rs

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).

Different types of Factoring



Disclosed and Undisclosed

Recourse and Non recourse

A single factoring company may not offer all these services.

Disclosed

In disclosed factoring client's customers are notified of the factoring agreement. Disclosed type can either be recourse or non recourse.

Undisclosed

In undisclosed factoring, client's customers are not notified of the factoring arrangement. Sales ledger administration and collection of debts are undertaken by the client himself. Client has to pay the amount to the factor irrespective of whether customer has paid or not. But in disclosed type factor may or may not be responsible for the collection of debts depending on  whether it is recourse or non recourse.



Recourse factoring

In recourse factoring, client undertakes to collect the debts from the customer. If the customer don't pay the amount on maturity, factor will recover the amount from the client. This is the most common type of factoring. Recourse factoring is offered at a lower interest rate since the risk by the factor is low. Balance amount is paid to client when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts from the customer. Balance amount is paid to client at the end of the credit period or when the customer pays the factor whichever comes first. The advantage of non recourse factoring is that continuous factoring will eliminate the need for credit and collection departments in the organization.



Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com

SBI Factors and Commercial Services Pvt. Ltd: http://www.sbifactors.com

The Hongkong and Shanghai Banking Corporation Ltd: http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services

Foremost Factors Limited: http://www.foremostfactors.net

Global Trade Finance Limited: http://www.gtfindia.com

Export Credit Guarantee Corporation of India Ltd: https://www.ecgc.in/Portal/productnservices/maturity/mfactoring.asp

Citibank NA, India: http://www.citibank.co.in

Small Industries Development Bank of India (SIDBI): http://www.sidbi.in/fac.asp

Standard Chartered Bank: www.standardchartered.co.in



FORFAITING

What is Forfaiting?



Forfaiting is a mechanism of financing exports:

by discounting export receivables

evidenced by bills of exchange or promissory notes

without recourse to the seller (viz., exporter)

carrying medium to long term maturities

on a fixed rate basis (discount)

upto 100 per cent of the contract value.



Benefits to exporter from forfaiting?

Benefits to exporter from forfaiting?

Converts a deferred payment export into a cash transaction, improving liquidity and cash flow.

Frees the exporter from cross-border political or commercial risks associated with export receivables.

Finance upto 100 per cent of the export value is possible as compared to 80-85 per cent financing available from conventional export credit programmes.

As forfaiting offers without recourse finance to an exporter, it does not impact the exporter’s borrowing limits. Thus, forfaiting represents an additional source of funding, contributing to improved liquidity and cash flow.