FACTORING

CHAPTER 1

INTRODUCTION TO FACTORING

Factoring is a type of financial service provided by the specialist

organizations. When small scale firms sell on credit basis, collection of

receivable poses a problem. In that case factoring organizations play an

important role in collection of debtors. Factoring involves sale of receivables

to specialized firm, called factors. Factors collect receivables and also

advance cash against receivables to solve the client firm’s liquidity problem.

For providing their services, they charge interest on advance and

commission for other services. In other words, factoring is an arrangement

under which a financial institution (called factor) undertakes the task of

collecting the book debts of its client in return for a service charge in the

form of discount or rebate. The factoring institution eliminates the client’s

risk of bad debts by taking over the responsibility of book debts due to the

client. The factoring institution advances a proportion of the value of book

debts of the client immediately and the balance on maturity of book debts.

DEFINITION

“Factoring is a service involving the purchase by a financial

organization, called a factor, of receivables owned to manufacturer and

distributors by their customers, with the factor assuming full credit and

collection responsibilities.”

“Factoring is a service of financial nature involving the conversion of

credit bills into cash.”

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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 varies 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).

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FACTORING

MECHANISM

A factor provides finance to his client upto a certain percentage of the

unpaid invoices which represent the sales of goods or services to approved

customers. The mechanism of the factoring scheme is as follows:

There should be a factoring arrangement (invoice purchasing

arrangement) between the client (which sells the goods and services to

trade customer in credit) and the factor, which is the financing

organization.

Whenever the client sells goods to the trade customers on credit he

prepares invoices in the usual way.

The goods are sent to the buyers without raising a bill of exchange but

accompanied by an invoice.

The debt due by the purchaser to the client is assigned to the factor by

advising the trade customers to pay the amount due to the client, to the

factor.

The client hands over the invoices to the factor under cover of a

schedule of offer along with the copies of invoices and receipted

delivery challans.

The factor makes an immediate payment upto 80% of the assigned

invoices and the balance 20% will be paid on realization of the debt.

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Factor

ClientCustomer

Pays the amount (In recourse type customer pays through client)

credit sale of goods

Invoice

Submit invoice copy

Payment up to 80% initially

Pays the balance amount

FACTORING

TERMS AND CONDITIONS

Assignment of debt in favor of the factor,

Selling limits for the client,

Conditions within which the factor will have recourse to the client in

case of non-payment by the trade customer,

Circumstances under which the factor for his services, say for

instance, as a certain percentage on turnover,

Interest to be allowed to the factor on the account where credit has

been sanctioned to the supplier, and

Limit of any overdraft facility and the rate of interest to be charged by

factor.

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FACTORING

CHAPTER 2

TYPES OF FACTORING

o Recourse and Non-recourse Factoring

Under a recourse factoring arrangement, the factor has recourse to the

client (firm) if the debt purchased/receivables factored turns out to be

irrecoverable. If the customer defaults in payment, the client has to makes good

the loss incurred by the factor. The factor charges the client for maintaining the

sales ledger and debt collection services and also for the interest for the period

on the amount drawn by the client.

The factor does not have the right of recourse in the case of non-recourse

factoring. The loss arising out of irrecoverable receivables is borne by him, as a

compensation which he charges a higher commission.

o Advance and Maturity Factoring

A drawing limit, as a pre-payment, is made available by the factor to the

client as soon as the factored debts are approved. The client has to pay interest

on the advance between the date of such payment and the date of actual

collection from the customers.

The maturing factoring is also known as Collection factoring. Under such

arrangements, the factor does not make a pre-payment to the client. The

payment is made either on the guaranteed payment date or on the date of

collection.

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FACTORING

o Full Factoring

This is the most comprehensive form of factoring combining the features

of almost all the factoring services specially those of non-recourse and advance

factoring. Full factoring provides the entire spectrum of services (collection,

credit protection, sales ledger administration and short term finance).

o Disclosed and Undisclosed Factoring

In disclosed factoring, the name of the factor is disclosed in the invoice

by the supplier-manufacturer of the goods asking the buyer to make payment to

the factor. The supplier may continue to bear the risk of non-payment by the

buyer without passing it on to the factor.

The name of the factor is not disclosed in the invoice in undisclosed

factoring although the factor maintains the sales ledger of the supplier

manufacturer. The entire realization of the business transaction is done in the

name of Supplier Company but all control remains with the factor. He also

provides short-term finance against sales invoice.

o Domestic and Export/Cross-Border/International Factoring

In the domestic factoring, the three parties involved, namely,

customer(buyer), client(seller-supplier) and factor (financial intermediary) are

domiciled in the same country.

The process of export factoring is almost similar to domestic factoring

except in respect of the parties involved. There are usually four parties involved

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FACTORING

in cross-border factoring transaction. They are: exporter (client), importer

(customer), export factor and import factor.

CHAPTER 3

FUNCTIONS OF A FACTOR

Administration of sales ledger

The factor maintain sales ledger in respect of each client when the sales

transaction takes place an invoice is prepared in duplicate by the client,

One copy is given to customer and second copy is sent to the factor.

Entries are made in the ledger on open item method. Each receipt is

matched against the specific invoice. On any given date the customer

account indicate the various open invoices outstanding. Periodic reports

are sent by factor to the client with respect to current status of transaction

the periodicity of report is decided. Thus the entire sales ledger

administration responsibility of the client gets transferred to factor.

Collection of Receivables

The main function of the factor is to collect the receivable on the behalf

of the client and to relieve him from all the botherations problems

associated with the collection. This way the client can concentrate on

other major areas of his business on one hand and reduce the cost of

collection by way of saving in labour time and efforts on the other hand.

The factor possesses trained and experienced personal, sophisticated

infrastructure and improve technology which helps him to make timely

demands on the debtors to make payments.

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FACTORING

Provision of Finance

Finance which is the life blood of a business, is made available easily by

the factor to the client. A factor purchased the book debts of his client

and debts are assigned in favour of the factor. Around 75% to 80% of the

assigned debts are given as advance to the client by the factor.

Protection Against Risk

This services is provided where the debts are factored without resources.

The factor fixes the credit limit in respect of approved customers. Within

this limit the factor undertakes to purchase all trade debts and assumes

risk of default in payment by the customers. The factor not only relives

the client from the collection work but also advises the client on the

creditworthiness of potential customers. Thus the factor helps the client

in adopting better credit control policy. The credit standing of the

customers is assessed by the factors on the basis of information collected

from credit rating reports, bank reports, trade reference, financial

statement analysis and by calculating the important ratios in respect of

liquidity and probability position.

Advisory Services

These services arise out of the close relationship between a factor and a

client. Since the factor have better knowledge and wide experience in

field of finance, and possess extensive credit information about

customers standing.

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FACTORING

They also, provide various advisory services on the matters relating to:

Customer’s preferences regarding the client products.

Changes in marketing polices of the competitors

Suggest improvements in the procedures adopted for invoicing,

delivery and sales return.

Helping the clients for raising finance from banks /financial

institutions, etc.

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FACTORING

CHAPTER 4

THE HISTORY OF FACTORING

Factoring has a long and rich tradition, dating back 4,000 years. The

Mesopotamians used factoring in their business dealings. Almost every

civilization that valued commerce has practiced some form of factoring,

including the Romans who were the first to sell actual promissory notes on a

secondary market at a discount.

Factoring gained true popularity, however, in trade between the American

colonists and their European buyers. Prior to the American Revolution,

merchants in the colonies sent raw materials, from timber to wool to cotton

to furs, to British and European merchants. However, sending the goods

such long distances could get expensive. And in the meanwhile, waiting for

payment to come back across the Atlantic from Britain and Europe could

cause delays in being able to do what was necessary to harvest and plant and

process new orders.

In order to get around these problems, the British and European merchants

paid the colonists in part for the materials. This way, the colonists had an

advance with which to continue their operations. These eased cash flow and

created a streamlined process for ensuring that trade continued unabated.

As society progressed after the American Revolution, and as the Industrial

Revolution came, the focus of factoring changed. Credit became more

important to factoring. The credit of the company itself was not as important

as the credit of its clients. Indeed, in many cases, factors helped companies

figure out which of its customers were the most credit worthy. This way,

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FACTORING

factors could also help companies keep their cash flow moving. They

advanced companies capital based on what was owed them by their credit

worthy customers.

Before the 1930s, the most popular industries for factoring were the garment

and textile industries. These are industries that rely on raw materials. In

order to make sure that companies could continue to buy raw materials to

produce clothing and textiles, factoring was used. However, it soon became

evident, after World War II, that factoring could work effectively for any

business that invoiced others.

During the 1960s, 1970s and 1980s, interest rates were on the rise and banks

were increasingly regulated. This made it difficult for companies to get

traditional financing. Factoring became even more popular, since it did not

require the same sort of credit checks. Additionally, since the invoices were

bought – deducting the fees – it was possible to avoid the some sort of

interest charges. Small business, startups and rapidly growing businesses

benefitted especially from this increase in factoring. Factoring grew as a

service as business people found their options contracting.

Today, factoring remains a viable alternative to more traditional financing.

Thousands of businesses sell their accounts receivable to factors every year

– amounting to an industry representing billions of dollars. And nearly any

business with reliable customers and an invoicing system can take advantage

of factoring

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FACTORING

CHAPTER 5

FACTORING SERVICES IN INDIA

Factoring services had been introduced since 1991 in India, but still it

is quite new in the sense that factoring product is not widely known in many

parts of the country. Recognizing the utility of factoring services for small

and medium size industrial and commercial enterprises in India, for the first

time the Vaghul Committee which submitted its report on the Money

Market, recommended the development of a system of factoring of open

account sales particularly for the small scale industrial units. This committee

further observed that both banks and non-bank financial institutions in the

private sector should be encouraged to set up institutions for providing

factoring services. Later, the Kalyanasundaram Committee, which was

appointed by the Reserve Bank of India (RBI) in 1988 specifically for

exploring the possibilities of launching factoring services in India, found an

abundant scope for such services and hence strongly advocated for the

introduction of factoring services in India. This committee also observed that

banks were ideally suited for providing factoring services to the industries in

the economy. However, the said Committeeexpressed the view that to begin

with only four or five banks either individually or jointly should be allowed

on zonal basis to undertake factoring services.

The recommendations of Kalyanasundaram Committee were accepted

by the RBI. Subsequently a suitable amendment was made in the Banking

Regulation Act 1949, so as to allow banks to set up subsidiary company for

undertaking factoring services.

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FACTORING

To begin with, the RBI permitted both the State Bank of India and

Canara Bank to start factoring services through their own subsidiaries.

Accordingly, two factoring companies in India, i.e. SBI Factors and

Commercial Services Ltd. and Canbank Factors Ltd; sponsored by the State

Bank of India and Canara Bank respectively, commenced operations in

1991. In the beginning they were allowed to operate in Western and

Southern Zone of India respectively. However, later on, the RBI lifted these

area restrictions on their operations and accordingly, both these companies

were given permission to expand and operate their business in other parts of

the country. In view of this, they can operate on all-India basis.

In 1993 the RBI allowed all the scheduled commercial banks to

introduce factoring services either departmentally or through a subsidiary

set-up. Besides SBI Factors and Commercial Services and Canbank Factors

Ltd., there are a few non-banking finance companies such as Formost

Factors Ltd., Global Trade Finance Pvt. Ltd. (a subsidiary of EXIM Bank)

and Integrated Financial Services Ltd., which are also in the business of

domestic factoring in India. Of these, Global Trade Finance Pvt. Ltd. and

Formost Factors Ltd. have undertaken the business of export factoring also.

Besides these non-banking finance companies, Small Industries

Development Bank of India (SIDBI), Hongkong and Shanghai Banking

Corporation have been offering factoring services to their clients. Almost all

of them have been providing factoring services to the SSI and non-SSI units.

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FACTORING

Factoring Companies in India

o Canbank Factors Limited

o SBI Factors and Commercial Services Pvt. Ltd

o The Hongkong and Shanghai Banking Corporation Ltd

o Foremost Factors Limited

o Global Trade Finance Limited

o Export Credit Guarantee Corporation of India Ltd

o Citibank NA, India

o Small Industries Development Bank of India (SIDBI)

o Standard Chartered Bank

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FACTORING

CHAPTER 6

DOMESTIC FACTORING

Overview

Like International Factoring, in domestic factoring invoices are raised on

open account sale of goods and are assigned to SBIGFL for financing,

collection, and sales ledger administration.

Product features

Financing the seller by prepaying upto 90% of the invoice value/

Bill value

Protection against default in payment by the buyer by arranging for

insurance cover 

Collection of receivables

Maintenance of accounts relating to accounts receivables (A/R) 

Characteristics of factorable transactions

Domestic Receivables that can be factored should have the following

characteristics:

The seller’s performance obligations should be completed at the

time the seller presents an invoice for prepayment.

There should be multiple shipments or a continuous sales flow on an

ongoing basis with the same buyer or buyer(s).

Factoring transactions necessarily require credit terms and are best

suited for credit periods of upto 120 days. However, factoring

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FACTORING

transactions can also be structured for credit sales for upto 180 days.

LC's are not required

Factoring facilities are typically provided for "open account"

transactions and can also be structured for transactions involving

negotiable instruments such as bills of exchange or promissory

notes, on a case to case basis.

Factoring, necessarily, requires the assignment of whole turnover with a

buyer. Hence, all credit sales to a buyer have to be assigned to SBIGFL on

a continuous basis once the factoring arrangement is in place

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FACTORING

CHAPTER 7

INTERNATIONAL FACTORING

Overview

The use of the Factor/Agent grew throughout the Middle Ages. During the

period of colonization by European countries from the sixteenth century

onwards, exporters of consumer goods from Europe sought the help of these

mercantile Agents or Factors to promote their trade. The concept spread

across the Atlantic and grew rapidly in the United States, as there was a

significant demand for European merchandise. The services of the Factors

during that period usually included the following:

Taking physical possession of the goods on consignment

Storing them

Finding buyers and delivering the goods to them

Collecting payment from the buyers

From its humble origin, factoring has come a long way today. It has gained

lot of prominence and acceptance and is being offered as a valuable financial

product among major financial institutions and banks.

International factoring 

International factoring is a comprehensive receivable management service

encompassing finance, credit protection, collection and sales ledger

management for exports on open account terms.

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FACTORING

Product features

Finance to the exporter by prepaying upto 95% of the invoice value

Protection against default in payment by the buyer by arranging for

credit cover

Collection of receivables

Maintenance of accounts relating to accounts receivables (A/R)

LC's are not required

Characteristics of Factorable Exports

Export Receivables that can be factored should have the following

characteristics:

Buyer's country should be acceptable.

The exporter's performance obligations should be completed at the

time the exporter presents an invoice for prepayment. Performance

under turnkey contracts involving execution or commissioning of

equipment is usually not factorable.

There should be multiple shipments or a continuous sales flow on an

ongoing basis with the same buyer or buyer(s).

LC's are not required

Factoring transactions necessarily require credit terms and are best

suited for credit periods of upto 120 days. However, factoring

transactions can also be structured for credit sales for upto 180 days.

Factoring facilities are typically provided for "open

account" transactions and can also be structured for transactions

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FACTORING

involving negotiable instruments such as bills of exchange or

promissory notes, on a case to case basis.

Factoring necessarily requires the assignment of whole

turnover with a buyer.

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FACTORING

CHAPTER 8

IMPORT FACTORING

Import factoring is a financial service that enables you to purchase goods

from your overseas supplier on short term credit of upto 180 days on open

account terms without the need for opening a letter of credit (LC).

As an importer, you will receive credit from your overseas suppliers

without incurring any additional cost charged to a factor like SBIGFL.

Your primary obligation would be to make payment to the Factor on the

due date.

Imports that can be Factored

As Import Factoring covers imports upto 180 days, generally import of raw

materials and intermediates can be covered.

To Use Import Factoring

You have a supplier who insists on an LC to be opened or needs some

other assurance of payment. If an LC is opened, you tie up cash credit limit

with your bank apart from incurring costs for opening the LC.

Import Factoring is a new alternative to opening of an LC. As a result, your

supplier will be able to offer open account trading to you combined with

his need for the credit risks to be covered. 

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FACTORING

Working of Import Factoring

Import factoring works on a two factor platform. Your supplier approaches

an Export Factor in his country and requests for a credit line on you. The

Export Factor applies to the Import Factor for collection and due date

payment services and evaluation of credit risk on you.

We grant a credit line to the Export Factor on evaluation of your Company.

Credit line means a credit risk evaluation up to the specific amount and

refers to buyer insolvency or inability to pay. As soon as the factoring

agreement is concluded between the supplier and the Export Factor, you

can start to purchase the goods from your supplier on open account terms

without opening a LC. On due date, you will pay the amount against full

discharge of your liability.

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FACTORING

CHAPTER 9

SBI GLOBAL FACTORS LTD

Background

SBI Factors was established in February, 1991 with the primary objective

of providing domestic factoring services to Small and Medium Enterprises

(SME). SBI Factors was merged with GTF w.e.f. February 11, 2010 to

form SBI Global Factors Ltd (SGFL).

SGFL is the largest factoring company in India and is the only provider of

international factoring, domestic factoring and forfaiting services under one

roof along with value added services to its clients.

Management

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FACTORING

The SBI group remains the major shareholder (85%) post merger which is

a comforting factor for the credit profile of SGFL. SBI has deputed senior

management personnel appointed senior management on the Board of

Directors and key management positions of SGFL. Mr. Pratip Chaudhari

(Chairman, SBI) is the Chairman of SGFL. In addition to the management,

SBI has also extended support through its brand and logo to be associated

with SGFL. This highlights the strategic importance of SGFL to the SBI

group and SBI is expected to provide management as well as operational

and financial support from financial support to SGFL.

Asset Profile

SGFL offers various products under factoring like, Domestic Factoring,

Export Factoring, Import Factoring and Factoring against Letter of Credit

(LC). SGFL had total turnover of Rs.12, 978 crore during FY10 as

compared to Rs.18,282 crore (standalone GTF). Majority of the turnover

(64%) was in domestic factoring followed by factoring against LC. A

product wise break up of turnover is given below:

Products FY09* % FY10* % H1FY11*

Domestic Factoring 12,180 67 6,203 48 2,524

Receivable Factoring 2,292 13 1,092 8 374

Export Factoring 435 2 1,142 9 444

Import Factoring 1,121 6 38 0 8

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FACTORING

Funding against LC 2,255 12 4,502 35 601

TOTAL 18,282 100 12,978 100 3,951

* Figures for FY09 are for GTF and that for FY10 and H1FY11 are for

merged entity and hence not directly comparable

During H1FY11, turnover was moderate at Rs.3951 crore as the focus of

the management is to have controlled growth to

improve the asset quality of the portfolio.

Asset Quality

SGFL has major exposure to SME sector which led to sharp deterioration in

its asset quality during FY09 and FY10 as the sector was impacted due to

economic slowdown. SGFL had slippages in few large value exposures due

to which it reported Gross NPAs of Rs.635 crore and Net NPA of Rs.507

crore as on March 31, 2010. SGFL’s Gross NPA ratio stood at 20.96% while

net NPA to Net worth ratio stood high at 97.14% as on March 31, 2010.

Majority of the NPAs were observed in the reverse factoring and import

factoring products which had higher proportion in GTF’s portfolio as

compared to that of SBI Factors. Currently, SGFL is focused only on

domestic factoring and has decreased the exposure in other products. It has

also taken stringent steps to improve its underwriting process and standards

to improve the asset quality. SGFL is also in the process of providing and

writing off its portfolio to clean its balance sheet. Increase in provisioning

and write-off cost is likely to have severe impact on profitability and capital

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FACTORING

adequacy of SGFL in the next two years. Improvement in asset quality

would remain a key rating sensitivity for SGFL.

Resources Profile

Resources profile is characterised by high dependence of SGFL on market

borrowings and bank finance. Net worth constituted around 17% of total

liabilities as on March 31, 2010. Since the average tenor of receivables is

low (90 to 120 days) majority of the borrowings as on March 31, 2010 were

short term borrowings from banks (comprising 57% of total borrowings).

However, during H1FY11, due to change to base-rate scenario, SGFL’s cost

of borrowing from banks increased due to which it moved towards market

borrowings through issue of Commercial Paper (CP) which constituted 50%

of total borrowings as on September 30, 2010. SGFL, reported Capital

Adequacy Ratio of 19.88% as on March 31, 2010. However, considering the

deterioration in the asset quality, capital support from parent company may

be required and would be a key rating sensitivity.SBI has infused Rs.50

crore into SGFL during March, 2011 as capital.

Financials

The merger of SBI Factors and GTF took place with effect from February

11, 2010. The appointed date for the merger is April 1, 2009. Financials for

FY10 were the first set of accounts of SGFL. During FY10, SGFL reduced

its operations to prevent further deterioration in asset quality thereby

resulting into lower income. SGFL reported total income of Rs.493 crore

during FY10 as compared to income of Rs.512 crore (of standalone GTF)

during FY09. It reported Profit After Tax (PAT) of Rs.7 crore during FY10.

During the year, SGFL reported provision and write-off of NPAs amount

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FACTORING

ting to Rs.242 crore which severely impacted the profitability of the

company. However, the operating level profitability remained good. Overall

gearing was moderate at 4.94 times whereas interest coverage stood low at

1.1x as on March 31, 2010.

Performance for H1FY11

During H1FY11, SGFL saw moderate portfolio growth with majority of the

portfolio being towards domestic factoring. It reported total income of

Rs.132 crore for the period. During H1FY11, it made provision and

write-off on NPAs of Rs.114 crore which resulted in SGFL reporting loss of

Rs.49 crore for H1FY11.

CHAPTER 10

ADVANTAGE AND DISADVANTAGE OF FACTORING

BENEFITS OF FACTORING

There are many benefits to companies that choose to factor. In

Addition to avoiding all the paper work associated with obtaining traditional

financing, factoring is easy and generally provides instant cash. Below is a

list of additional benefits of factoring:

o Receive an Influx of Working Capital

The primary benefit of factoring is that it helps your business get the

working capital it needs without taking on new debt or diluting ownership of

your company by bringing in new investors. Because today's economic

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FACTORING

environment is highly competitive, many businesses are under immense

pressure to improve operations and undertake cost cutting measures in order

to stay profitable. These problems are compounded for small businesses

becasue most small businesses are often times understaffed to begin with. As

a result, owners of small businesses frequently spend more time on cash

flow and customer credit issues rather than on their primary objectives of

growing their business, increasing sales, managing marketing campaigns and

improving employee productivity.

Many small businesses experience serious cash flow problems

because their cash is tied up in their accounts receivable. For businesses that

are growing, the cash flow problems can be even worse because more and

more of their capital is not in their bank account, but is on the balance sheet

as receivables. Most businesses want to grow and expand, but if appropriate

planning is not done, an entire business will feel the squeeze because it is

undercapitalized. Invoice factoring is a solution to free up your capital and

have it available when you need it. Your business will be able to invest

resources in areas where it can help you become more profitable, such as

payment discounts or taking advantage of promtional prices for inventory or

supplies.

o Improve Cash Flow Without Borrowing From a Bank

It can eliminate long billing cycles and receive cash for outstanding

invoices generally within 48 hours of less.  Since factoring is not a loan, it

take on no new debt and maintain company's leverage to take on new debt in

the future.

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FACTORING

o Capitalize on Supplier Discounts

Many suppliers offer discounts if they are paid in a short period of

time.  By factoring, accelerate cash flow allowing to pay suppliers earlier

and take advantage of supplier discounts or buy in larger quantities.

o Build or Repair Credit Rating and Credit Score

Since factoring will give an immediate cash, it can pay the bills on

time, or possibly even early, allowing to build or repair credit rating.

Improving your credit rating and raising your credit score will give you

increased borrowing power.

o Secure Capital By Leveraging Assets

Factor is based on the credit worthiness of customers, you can get

the cash business needs by leveraging outstanding receivables.

ADVANTAGES

Benefits of Factoring to Clients

o Under the factoring arrangement the client receives prepayment upto

80-90 percent of the invoice value immediately and the balance

amount after the maturity period. This helps the client to improve cash

flow position which enables him to have better flexibility in managing

working capital funds in an efficient and effective manner.

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FACTORING

o If the client avails the services of the factor in respect of sales ledger

administration and collection of receivables, he need not have any

administrative set up for this purpose. Naturally this will result into a

substantial saving in time and cost of maintaining own sales ledger

administration and collecting receivables from the customer. Thus, it

will reduce administrative cost and time.

o When without recourse factoring arrangement is made, the client can

eliminate the losses on account of bad debts. This will help him to

concentrate more on maximizing production and sales. Thus, it will

result in increase in sales, increase in business and increase in profit.

o The client can avail advisory services from the factor by virtue of his

expertise and experience in the areas of finance and marketing. This

will help the client to improve efficiency and productivity of his

organization. Besides this, with the help of data base, the factor can

readily provide information regarding product design/mix, prices,

market conditions etc., to the client which could be useful to him for

business decisions.

The above mentioned benefits will accrue to the client provided he develops

a better business relationship with the factor and both of them have mutual

trust in each other.

DISADVANTAGES

o Image of the client may suffer as engaging a factoring agency is not

considered a good sign of efficient management.

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FACTORING

o Factoring may not be of much use where companies or agents have

one time sales with the customers.

o Factoring increases cost of finance and thus cost of running the

business.

o If the client has cheaper means of finance and credit (where goods are

sold against advance payment), factoring may not be useful.

CHAPTER 11

CASE STUDY OF SUNLIGHT INDUSTRIES LTD.

Sunlight Industries Ltd. manages its account receivables by its sales

and credit department. The cost of sales ledger administration stands at

Rs. 9 crore annually. It supplies chemicals to heavy industries. These

chemicals are used as raw material for further use or are directly sold to

industrial units for consumption. There is a good demand for both the types

of uses. For the direct consumers, the company has a credit policy 2/10,

net 30. Past experience of the company has been that on avg. 40% of the

customer avail of the discount while the balance of the receivables are

collected on an avg. 75 days after the invoice date. Sunlight industries also

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FACTORING

has small dealer networks that shall the chemicals bad debt of the company

are currently 1.5% of total sales.

Sunlight industries finances its investment in debtors through a mix of

bank credit and own long term funds in the ratio of 60:40 current cost of

bank credit and long term funds are 12% and 15% respectively.

There has been a consistent rise in the sales of company due to its

proactive measures in cost reduction and maintaining good relations with

dealers and customers. The projected sales for the next year are Rs 800 crore

of 50% from last year. Gross profits have been maintain at a healthy 22%

over the years and are expected to continue in futures.

With escalating cost associated with the in-house management of

debtors coupled with the need to unburden the management with the task so

as to focus on sales promotion, the CEO of Sunlight Industry examine the

possibility of outsourcing its factoring service for managing its receivables.

He assigns the responsibility to Anita Guha, the CFO of Sunlight. Two

proposals the details of which are given below are available for Anita’s

consideration.

Proposal from Canbank Factors Ltd.

The main element of the proposal are :

i. Guaranteed payment within 30 days

ii. Advance, 88% and 84% for the recourse and non-recourse

arrangement respectively

iii. Discount charge in advance 21% for recourse and 22% without

recourse

iv. Commission, 4.5% without recourse and 2.5% with recourse

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FACTORING

Proposal from Indbank Factors Ltd.

The main element of the proposal are :

i. Guaranteed payment within 30 days

ii. Advance 84% with recourse and 80% without recourse

iii. Discount charge upfront, without recourse 21% and with recourse

20%

iv. Commission upfront, without recourse 3.6% and with recorse 1.8%

The opinion of the chief Marketing manager is that in context of the

factoring arrangement his staff would be able to exclusively focus on sales

promotion which would result on additional sales of Rs 75 crore.

Financial Analysis of Receivables Management Alternatives (Rs. in Crore)

Particulars Amount

(A) In house Management :

Cash discount (Rs. 800 crore X 0.40 X 0.20)

Bad debts (Rs. 800 crore X 0.015)

Opportunity Cost (Forgone contribution on lost sales)

(Rs. 75 crore X 0.205 net of bad debts)

Avoidable administrative and selling expenses

Cost of investment in receivables ©

Total Cost

6.4

12.0

15.4

9.0

14.4

57.2

© Avg. collection period = 49 days [(0.40 X 10 days) + (0.60 X 75days)]

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FACTORING

Investment in debtors: = Rs. 14.4 crore

[(Rs. 108.9 crore X 0.60 X 0.12) + (Rs. 108.9 crore X 0.40 X 0.15)]

(Rs. in Crore)

Particulars Amount Amount

(B) Canbank factors Proposal:

Factoring Commission

(Rs 875 crore X 0.025)

(Rs 875 crore X 0.045)

Discount charge

[Rs. 750.7* crore X 0.21 X (30/360)]

[Rs. 701.9** crore X 0.22 X (30/360)]

Cost of long term funds in debtors:

{[( Rs. 875 crore – Rs. 750.7 crore)] X

[0.15 X (30/360)]}

{[( Rs. 875 crore – Rs. 701.9 crore)] X

[0.15 X (30/360)]}

With recourse

21.9

-

13.1

-

1.6

-

36.6

Without recourse

-

39.4

-

12.9

-

2.2

54.5

* Amount of Advance = Rs. 750.7crore [0.88 X (Rs. 875 cr. – Rs. 21.9 cr.)]

** Amount of Advance = Rs. 701.9crore [0.84 X (Rs. 875 cr. – Rs. 39.4 cr.)]

(Rs. in Crore)

Particulars Amount Amount

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FACTORING

(C) Indbank Factor Proposal

Factoring Commission

(Rs 875 crore X 0.018)

(Rs 875 crore X 0.036)

Discount charge

[Rs. 721.8# crore X 0.20 X (30/360)]

[Rs. 674.8## crore X 0.21 X (30/360)]

Cost of long term funds in debtors:

{[(Rs. 875 crore – Rs. 721.8 crore)] X

[0.15 X (30/360)]}

{[(Rs. 875 crore – Rs.674.8 crore)] X

[0.15 X (30/360)]}

With recourse

15.7

-

12.0

-

1.9

-

29.6

Without recourse

-

31.5

-

11.8

-

2.5

45.8

# Amount of Advance = Rs. 721.8 cr. [0.84 X (Rs. 875 cr. – Rs. 15.7 cr.)] ## Amount of Advance = Rs. 674.8 cr. [0.80 X (Rs. 875cr. – Rs. 31.5 cr.)]

(Rs. in Crore)

Decision Analysis: Recourse Factoring

Particulars Canbank Indbank

Benefits (Rs. 57.2 cr. – Rs. 12 cr.)

(Bad debts to be borne by company)

Costs

Net Benefits

45.2

36.6

8.6

45.2

29.6

15.6

Decision Analysis: Non-Recourse Factoring

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FACTORING

Particulars Canbank Indbank

Benefits (Rs. 57.2 cr. + Rs. 1.1cr.)

(Bad debts to be borne by factor)

Costs

Net Benefits

58.3

54.5

3.8

58.3

45.8

12.5

Advice: My advice to the CFO of Sunlight Industries would be to accept the

proposal of Indbank Factors for Recourse Factoring.

CHAPTER 12

CONCLUSION

o Factoring is a money market instrument.

o Since, factoring is not a negotiable instrument, customer’s consent is

required about the factoring arrangement under which he will make a

repayment directly to the factor but not to the client.

o As a result of factoring services, the enterprise can concentrate on

manufacturing and selling.

o The risk of bad debts is eliminated.

o The factoring institution also provides advice on business trends and other

related matters.

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FACTORING

BIBLIOGRAPHY

BOOKS:

o Financial Services In India - G. Ramesh Babu

o Financial Services - By Khan

o International Factoring in India: Issues, Problems & Prospects

- A K Sengupta, V S Kaveri

MAGAZINES:

o Business Standard

NEWSPAPER:

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FACTORING

o Economic Times

WEBSITES:

o www.canbankfactors.com

o www.sbiglobal.in

o http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services

o www.standardchartered.co.in

o www.citibank.co.in

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