FACTORING
Firms sell goods on cash and credit
basis. When goods are sold on credit basis, bills are drawn on the buyer by the
seller. In case of small and medium business, a considerable part of their
working capital is tied down in bills
receivables. The liquidity position of the firm is affected and this hinders
the smooth functioning of the business. In order to overcome this hurdle,
Factoring as a service has emerged.
Factoring is derived from a Latin term
“facere” which means ‘to make or do’. Factoring is an arrangement wherein the
trade debts of a company are sold to a financial institution at a discount. The
factor is an agent who buys the accounts receivables (Debtors and Bills
Receivables) of a firm and provides finance to a firm to meet its working
capital requirements.The main advantage of factoring is that the small or big
business firm receives short term finance (working capital) to meet day-to- day
payments.
In a report submitted to the Reserve
Bank of India, Mr.C.S.Kalyanasundaram defines factoring as “a continuing arrangement under which a
financing institution assumes the credit and collection functions for its
clients, purchases receivables as they arise (with or without recourse for
credit losses, i.e., the customer’s financial inability to pay), maintains the
sales ledgers, attends to other book-keeping duties relating to such accounts,
and performs other auxiliary duties”.
The Factoring Regulation Act 2011 governs the registration of factors and regulating the assignment of receivables and the associated obligations.
a.
The firm enters into a factoring
arrangement with a factor, which is generally a financial institution, for
invoice purchasing
b.
Whenever goods are sold on credit basis,
an invoice is raised and a copy of the same is sent to the factor.
c.
The
debt amount due
to the firm
is transferred to the factor through assignment and the same is
intimated to the customer.
d.
On the due date, the amount is collected
by the factor from the customer.
e. After retaining the service fees, the remaining amount is sent to the firm by the factor
a.
Maintenance of book-debts
A factor takes the responsibility of
maintaining the accounts of debtors of a business institution.
b.
Credit coverage
The factor accepts the risk burden of
loss of bad debts leaving the seller to concentrate on his core business.
c.
Cash advances
Around eighty percent of the total
amount of accounts receivables is paid as advance cash to the client.
d.
Collection service
Issuing reminders, receiving part
payments, collection of cheques form part of the factoring service.
e.
Advice to clients
From the past history of debtors, the factor is able to provide advices regarding the credit worthiness of customers, perception of customers about the products of the client, etc.
When a factor agrees to provide complete
set of services which includes financing, maintenance of sales ledger, debt
collection at his own risk, and providing consultancy services as and when
necessary, it is called as full servicing factoring.
When the factor does not undertake
credit risk, it is known as with recourse factoring. In case the debtor fails
to make the payment on due date, it is assigned back to the firm by the factor.
Here the responsibility of collecting the amount lies with the selling firm.
In this type, the factor agrees to
finance the firm only after collecting the amount on maturity from debtors.
When the claims of an exporter are
assigned to a financial institution and the finance is advanced on the basis of
export invoice it is called as international factoring.
The factoring process involving the
client firm, factor and the customer is given below.
Forfaiting is defined as “the
non-recourse purchase by a bank or any other financial institution of
receivables arising from an export of goods and services”.
Factoring helps smooth running of
business by getting short term credits from financial institutions against
accounts receivables. Forfaiting is a variation of factoring with focus on
international exports.
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