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.