Factoring and Forfaiting -A fund/fee based financial service Prof. Nishant Dhruv,
What is Factoring? Definition: Factoring provides resources to finance receivables as well as facilitates the collection of receivables
Functions Provision for collection of credit sales Administration of sales ledger Financing Trade Debt (Credit Sales) Credit Management and covering credit risk involved
Types of Factoring Recourse Factoring Non-recourse Factoring Advance and Maturity Factoring Old line Factoring/Full Factoring International Factoring
Mechanism of Factoring 1. Customer places order, client delivers good and sends invoice 2. Clients assigns invoice to factor 3. Factor makes prepayment (about 80%) 4. Monthly Statement of a/c to customers 5. Customer makes payment to factor 6. Factor makes balance 20 % payment to client
Cost of Factoring Services The factor provides various services at a charge. Costing can be segregated in two ways Commission : a charge for collection Discount Charge: interest charge, for short-term financing by factor between the date of advance payment and date of guaranteed payment
Legal Aspects of Factoring Client serves a notice of assignment to customers Client provides all evidences A factor requires a power of attorney to assign debts. Legal status of the factor is that of assignee Letter of disclaimer is required by factor in case of multiple finance Attracts stamp duty
Advantages of Factoring To the client (Company) Conversion of credit sales into cash Competitive credit terms to buyers Free from tensions of monitoring sales ledger Close interaction among working capital & other components Expand business To the customer (Buyers) Facilitates credit purchases Save on bank charges Less paperwork Does not impinge on the customer s rights
Cash Credit vis-à-vis Factoring Cash Credit Factoring Margin retained 40-50% Margin retained 20% Client submits various statements to banks Factor furnishes report to both client and cust. Banks do not render debt collection services No grace period allowed Variable processing fees Factor renders debt collection services Grace period allowed Fixed processing fees
Bill Discounting vis-à-vis Factoring Bills Discounting Always with Recourse Factoring Can be either Recourse or Non recourse Each bill to be individually accepted One time notification taken from customer Expensive source More paperwork Less expensive Less paperwork Facility only on Provision for Finance Also provides other services Submission of original documents required It is shown in balance sheet No assignment of debts Only copies of such documents It is off balance sheet mode Assignment of debts
Forfaiting Forfaiting is the discounting of international trade receivables on a 100% without (non) recourse basis.
Origin of Forfaiting The term forfait is a french word which means relinquish a right. Forfaiting has been evolved in around 1960s. In India, RBI approved forfaiting as an export financing option in the year 1992.
Characteristics of Forfaiting The exporter is insulated against the possibility of default. Trade receivables are required to be denominated in a freely convertible currency. Credit period can range from 60 days to 10 years. Forfaiting is flexible as well as tailormade.
An importer s obligation is normally supported by a local bank guarantee or an aval.
Forfaiting is used in following siuations: It s more suitable for high value exports. There should be request for deferred payment for more than 60 days. The contract is for atleast USD 1,00,000 or its equivalent, in a freely convertible currency. Either bank guarantee or letter of credit should be available.
Commercial bank usually do not fund credit risk beyond the period of 180 days. Hence
Pricing of a Forfaiting transaction The pricing consist of four elements : Interest Rate Commitment Fees Handling Fee
Flow chart of Forfaiting Transaction 1. Commitment to purchase debt 2. Commercial Contract 3. Delivery of Goods 4. Gives Guarantee 5. Forwarding the documents 6. Delivers documents 7. Makes Payment (Advance Payment) 8. Present document on maturity 9. Repays at Maturity 10. Payment to forfaiter.
Difference Between Forfaiting and Factoring Forfaiting Factoring For International credit For transactions of short-term transactions of long-term maturity maturities 100% financing without recourse Can be with or without recourse Cost borne by importer (buyer) Cost borne by seller(client) A forfaiter and a bank involved No bank involved Sales ledger is not administered The entire sales ledger is administered for some fixed fee