Discounting. Factoring & Forfeiting Summary

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1 Chapter 7 Discounting. Factoring & Forfeiting Summary The financial service sector is developing at rapid pace in India. This is just because of the emerging needs of the economy. Many innovative schemes have been introduced by this sector. The main & important area wherein it has been introduced is book debt finance. In forthcoming chapter, we are going to get introduction & information of three major types of book debt finance. Which are Bill discounting, Factoring & Forfeiting. : Bill Discounting : This is one of the oldest forms of book debt finance. Normally, lots of commercial banks provide this finance. In this finance, the supplier of goods draws bill on purchaser for 3 months to 9 months. This bill is purchased or discounted by bank. The possession of bill is with bank. The supplier gets immediate cash for his business. The bank charged interest & other charges for doing so. Bill financing is most liquid one, from the banker s point of view. Since in the time of emergencies, they can rediscount it with R.B.I. Bill discounting is superior to the conventional system of cash credit in following ways. a) High liquidity b) Quick & high yield c) Even if bill is dishonored, the bank has to simply note & protest the bill & debit to customer A/c. d) Last but not least, these bills are base for the maintenance of reserves like CRR & SLR. For these reasons R.B.I. has been trying to develop good bill market in India. The effective rate of interest on bill finance has been lowered by 1% below the cash credit rate. In spite of all efforts to promote good bill market, bill financing forms barely 5% of total credit extended by banks. The latest step of R.B.I. to promote bill market is the launching of the factoring service organisation. : Factoring : In small & medium size companies lot of working capital is blocked up in the form of real debts. The factoring may be right answer to this. The word factor is derived from Latin word Facere which means to make or to do in other word getting things done. The definition of factoring is given by many individuals as well as institutions. Some of them are as below:

2 According to Webster Dictionary: Factor is an agent, as a banking or insurance company, engaged in financing the operation of certain companies or in financing wholesale or retail trade sales, through the purchase of accounts receivables. Robert W. Johnson: Says Factoring is a service involving the purchase by financial organisation, called factor of receivables owned to manufacturers & distributors by their customers, with the factor assuming full credit & collection responsibilities. From all of above the factoring, in simple words can be stated as, it is nothing but financing through purchase of debtors. The factoring is type of book debt finance & where there is finance, the agreement is vital. Factoring also has an agreement between client & factor. The main points of the same are: Assignment of debts in favor of the factor Selling limits for clients Details of the payment to factor for his services etc. Thus factor becomes the provider of finance from debts. Now let s see the main functions of factor. As definition stated that, factoring is an assignment of book debts in favor of factor, the main function of factor is Purchase & collection of debts. Next one is sales ledger management, credit investigation & undertaking of credit risk, provision of finance against debts. Last one is rendering counselling services. The functions of factor are self-explanatory. It is not just only functions but also an important tool for clients to concentrate on production & other business activities without thinking too much about collection of debts, the recovery ratio etc. After seeing functions of factor, now let s look at different types of factoring. There are various types depending upon nature of transaction between factor & client. Following chart not only shows different types of factoring but also gives brief information about the same:

3 Types of Factoring Full Service Factoring: Under this type factor provide all kinds of services. With Resource Factoring: In This type, the factor does not assum credit risk. If debtor does not pay dues in time, such debts are automatically assigned back to the client. Maturity Factoring: It is also called collection factoring. As in this case, factor pay client when, debtors pays the amount. Bulk Factoring: This type is resorted to when the factor is not fully satisfied with financial conditions of the client. This is also called as Notified factoring. Invoice Factoring: In this type, simply provides finance against invoice without taking any other function.this type of factoring is very confidential, so it is calles Undisclosed factoring. International Factoring: Under his type, the service of factor are simply extended to international business. The expeorter gets immediate cash to the extent of 80% of the expert invoice. Limited Factoring: It is a type of factoring where, factor does not take up all the invoices of client. He discount only selected invoices. Suppliers Gurantee Factoring: This type of factoring is suitable for those, who sells goods through middlemen. Seller Based Factoring: In this type, seller sells all his accounts receivable to factor. This facility extended to reputed & credit worthy sellers & hence it is also called 'Selected Seller Based Factoring'. The above chart throws light on almost all functions, duties & responsibilities of factor. Which is really compelled us to distinguish between factoring & discounting. Although it looks alike but both can be distinguished on following points. Factoring Discounting Covers entire book debt. Factor becomes owner for value. Extend credit without any recourse client. Involves purchase, collection of debts & management of sales ledger. Registration does not require. Factoring is always Off-Balance Sheet financing. Covers only those, which are backed by A/c rec. Financier acts as agent of his customer. Made always with recourse client. Involves simply the provision of finance alone. Registration is required with register of company. Discounting is always in Balance sheet financing.

4 From above, it becomes very clear that, though it looks alike but actually factoring is very much differs from discounting. In the factoring, costing for different services is very important. Mainly costing is classified into two: a. Factoring fees or administrative charges b. Discount charges The former is charged for providing various services to client such as sales ledger administration, bad debts administration etc. & later is charged for providing instant credit to the client. Generally, factoring charges= cost + profit. In which cost refers to different costs i.e. direct cost, administration cost & profit refers to the profit, which factor wants to make from factoring. As we seen earlier, factoring company take charge of all book debts. Keeping following accounts does the same. 1. Sales ledger control A/c 3. Client control A/c 2. Debt Purchase A/c 4. Bank A/c Factoring offers number of benefits to the clients viz. 1. Offering financial service 2. Collection service 3. Off Balance sheet financing service 4. Credit risk service 5. Sales ledger management service 6. Consulting service In India, the thought of factoring services by the Vaghul working group subsequently RBI constituted study group in 1988 under the chairmanship of Mr. C.S.Kalyansundaram to examine the feasibility of factoring services. In July 1980, Banking Regulation Act was amended to enabling commercial bank to take up these services by forming separate subsidiaries. In Feb.1994, RBI permitted all banks to enter into factoring business departmentally. In India, factoring services first started by SBI, in association with Small Industries Development Bank of Saurashtra & State Bank of Indore. The pioneering factoring company founded by SBI called SBI- Factors & Commercial Services Pvt. Ltd. (SBI-FACS) in July 1991, with subscribed capital of Rs.25 crores. Generally, factoring services are very popular for domestic business. But due to modernisation of business, liberalisation of economic policies many domestic businessmen now entering into export business also. There are four types of export factoring viz. 1. Two factor systems 2. Single factor systems 3. Decent expert factor systems 4. Direct import factor systems Considering world wide factoring business, it is affected by recession across Europe. So some organization had to wind up their business in UK as well as in USA. And some had to merge their

5 business. Now more than 700 factoring companies are rating in some 40 countries. On the whole, the export factoring business total turnover worldwide during 1991 was $260 billion of which 6% is for export factoring. As per factor chain international, the global network of leading factoring companies. : Forfeiting : Forfeiting is another source of financing against receivables, like factoring. The term forfeit is French word denotes to give something or to give up one s right. The definition of forfeiting is, the non recourse purchase by a bank or any other financial institution, of receivables arising from export of goods & services. The factoring & forfeiting are used as tools of financing but they are different from each other on the basis of period, coverage, control, percentage of finance etc. The advantages of factoring can be stated as, it is simple & flexible, profitable & liquid, speedy & confidential, suitable for all kinds of export deals, 100% finance & rate of finance is fixed. Although the advantages of forfeiting are much more look alike. While exporting, finance through forfeiting is good option. But one must consider the disadvantages of the same, those are, 1. There is dominance of western countries & difficulty in procuring international bank guarantee. 2. Besides that forfeiting has gain substantial momentum abroad. It had its origin in Zurich, but well established in all financial centers in world. In India, forfeiting is slowly emerging as a new product in liberalised financial market. Union Govt. approved it in Forfeiting is done by EXIM Bank in India. The minimum value of forfeiting transaction is Rs.5,00,000/-. However to promote this type of finance business, it is necessary to quote export contracts in leading international currencies. Now, since the rupee has gaining strength, it is right time for us to denominate our trade obligations in foreign currencies so that this type of business get pace & resulted in to boosting our export trade.

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