1. Factoring and Forfaiting
MFS Chapter – 6 M. Y. KHAN
Factoring and Forfaiting

2. Factoring: The Concept…
“Factor is a financial intermediary which assumes the responsibility of collection of receivables arising out of credit sales of their clients and in return charges commission for its services”.
So, a Factor is…
A Financial Intermediary/Institute/Company
That buys invoices of a manufacturer or a trader, at a discount, and
Takes responsibility for collection of payments.

3. Factoring: The Concept…
“Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor) on the understanding that the Factor will pay for the Book Debts as and when they are collected or on a guaranteed payment date. Normally, the Factor makes a part payment (usually upto 80%) immediately after the debts are purchased thereby providing immediate liquidity to the Client”.

4. Factoring Services - Concept
Deliver of goods
Client
Customer
Order placed
Client submits invoice
Customer pays
Factor-Prepayment
Monthly statements
Factor
4/20/2017

5. Process of Factoring: Client makes a credit sale with a customer.
Client sells the customer’s account to the Factor and notifies the customer.
Factor makes partly payment (advance) against account purchased, after adjusting for commission and interest on the advance.
Factor maintains the customer’s account and follows up for payment.
Customer remits the amount due to the Factor.
Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date.

6. Charges for Factoring Services:
Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to 1.50%)
Commission is charged up-front.
For making immediate partly payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks.
If interest is charged up-front, it is called Discount.

7. Functions of a Factor:
1. Administration of sales ledger - Maintains the client’s sales ledger - Gives periodic reports - Current status of his receivables - Receipts of payments from customers - Customer-wise record of payments - Change in payment pattern 2. Provision of collection facility - Undertakes to collect receivables on behalf of the client - Relieving the clients from problems involved in collection - Enables the clients to reduce cost of collection

8. Functions of a Factor: CONT…
3. Financing Trade Debts:
4. Credit Control And Credit Protection:
This service is provided where debts are factored without recourse. Factor assumes the risk of default.
5. Advisory Services: - Specialized knowledge and experience - Customers’ perception - Change in marketing strategies - Emerging trends

9. Types / Forms of Factoring:
1. Recourse Factoring:
Factor does not assume credit risks associated with receivables.
Credit Risk is borne by the Client.
In India, Factoring is done with recourse.
2. Non-Recourse Factoring:
Factor assumes credit risks associated with receivables. Charges a higher commission
Credit risk is assumed by Factor
In USA/UK, Factoring is commonly done without recourse.

10. Types / Forms of Factoring:
3. Advance Factoring:
Factor pays a specified portion (75% to 90%) in advance.
Balance being paid upon collection from the customer. The client has to pay interest on advance payment.

11. Example of Advance Factoring Mechanism:

12. Types / Forms of Factoring: CONT…
4. Maturity Factoring / Collection Factoring:
Factor does not make any advance payment to the Client.
Factor Pays on date of collection/agreed future date.
Less RISK for Factor and charges nominal commission.
5. Full Factoring / Old Line Factoring:
Features of almost all the factoring services.
Entire spectrum of services; collection, credit protection, sales ledger administration, short-term finance.

13. Types / Forms of Factoring: CONT…
6. Disclosed Factoring:
Name of factor is disclosed in sales invoice.
7. Undisclosed Factoring:
Name of factor is NOT disclosed in sales invoice.
8. Domestic Factoring:
Buyer, Seller, Factor domiciled in the same country.

14. Types / Forms of Factoring: CONT…
9. Export / Cross Border / International Factoring:
Usually Four Parties Involved Viz. the Exporter, Importer, Export Factor, Import Factor.
Two Agreements.
Import Factor Provides Link Between Export Factor and Importer.
Import factor underwrites customer trade credit risk, collects receivables and transfers fund to export factor.

15. International Factoring Transactions:

16. Advantages of Factoring:
Off-balance Sheet Finance
Reduction of Current Liabilities
Improvement in Current Ratio
Higher Credit Standing:
More time for Planning and Production
Reduction of Cost and Expenses
Additional Source of Finance

17. WHY FACTORING HAS NOT BECOME POPULAR IN INDIA?
Banks’ unwillingness to provide factoring services
Problems in recovery.
Factoring requires assignment of debt which attracts Stamp Duty.
Cost of transaction becomes high.
Lack of awareness.

18. Factoring in INDIA: Major Players
SBI Factors and Commercial Services Pvt. Ltd.
Canbank Factors Limited
Global Trade Finance Limited
Foremost Factors Limited
HSBC Bank
CITI Bank NA, India
Standard Chartered Bank
SIDBI
ECGC Ltd.

19. FORFAITING: THE CONCEPT
“Forfeiting refers to financing of receivables pertaining to international trade”.
Forfaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him.
Converts exporter’s credit sale into cash sale.
Discounting the documents covering the entire risk of non- payment in collection.
Credit period can range from 3 to 5 years.

21. Characteristics of Forfaiting:
Converts Deferred Payment Exports into cash transactions, providing liquidity and cash flow to Exporter.
Discharge Exporter from Cross-border Political OR Exchange Risk associated with Export Receivables.
Finance available upto 100% (as against % under conventional credit) without recourse.
Acts as additional source of funding and hence does not have impact on Exporter’s borrowing limits. It does not reflect as debt in Exporter’s Balance Sheet.
Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise.

22. Characteristics of Forfaiting: Cont…
Exporter is freed from credit administration.
Simple Documentation as finance is available against bills.
Forfait financer is responsible for each of the Exporter’s trade transactions. Hence, Export business can be done more efficiently.
Forfait transactions are confidential.

23. FORFAITER’S CHARGES Cost of Forfaiting Margin to cover risk
The DISCOUNT charged by the Forfaiter depends upon:
Cost of Forfaiting
Margin to cover risk
Management charges
Fees for delayed payment
Period of Forfaiting contract
Credit rating of Avalling Bank
Country/Currency Risk of the importer

24. Export Factoring V/s Forfeiting:
Sr. No.
Export Factoring
Forfaiting 1
75 to 90% Financing
100% Financing 2
Financing, Collection, Sales
Ledger Administration
Pure Financing 3
Short Term Financing
3 To 5 Years 4
Does not guard against
Exchange Rate Fluctuation
Forfaiter guards.

25. FACTORING vs. FORFAITING
POINTS OF DIFFERENCE
FACTORING
FORFAITING
Extent of Finance
Usually 75 – 80% of the value of the invoice
100% of Invoice value
Credit Worthiness
Factor does the credit rating in case of non-recourse factoring transaction
The Forfaiting Bank relies on the creditability of the Availing Bank
Services provided
Day-to-day administration of sales and other allied/advisory services
No services are provided

26. FACTORING vs. FORFAITING – CONT…
POINTS OF DIFFERENCE
FACTORING
FORFAITING
Recourse
With or without recourse
Always without recourse
Size of transaction
Usually no restriction on minimum size of transactions that can be covered by factoring.
Transactions should be of a minimum value of USD 250,000.
Scope of service
Service is available for domestic and export receivables.
Usually available for export receivables only denominated in any freely convertible foreign currency.

27. WHY FORFAITING HAS NOT DEVELOPED…
Relatively new concept in India.
High Rupee Fluctuation
High cost of funds
High minimum cost of transactions (USD 250,000/-)
RBI Guidelines are unclear.
Very few institutions offer such services in India. Exim Bank is one of the major player and very few other co’s involved.
Lack of awareness.

28. List of some Forfaiters:
Standard Bank, London
Hong Kong Bank
ABN AMRO Bank
Meghraj Financial Services
Triumph International Finance India Ltd.,
Natwest Bank
Meridian Finance Group
4/20/2017