factoring process

8/3/2019 Factoring Process

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Factoring Process

Factoring is a simple extension of your current accounts receivable process.

1. Following your normal course of business, you sell your product or service to a customer,and issue an invoice for the value of the goods or service.

2. To factor the invoice, you follow the sale by sending the factor a copy of the invoice.

3. The factor processes the invoice, and within 24-28 hours, the factor gives you apercentage of the invoice amount, called an advance payment. This is the first of twopayments you receive when factoring an invoice.

4. The customer, when ready to make payment, directs payment to the factor.

5. When payment is received, the factor withholds a small factoring service fee, and returnsthe difference, or reserve back to you.

6. The reserve is the second payment you receive from the factor for the invoice. Functions of factoring:

1. Provide finance for the supplier, including loans and advance payments.2. Maintain accounts (ledgers relating to receivables)3. Collect the receivables and protect against risk of default in payment by the debtors.

The salient features of factoring can be outlined as follows:1. Factoring is a mode of financing as well as a financial service provided by the specialistcompanies called factors.

2. Factoring is a contractual service arising out of the agreement between the business firm(clients) and the factors.3. Factoring is a continuous arrangement between the factor and the client firms, because theinvoices of the client firm are continuously factored in.4. Factoring enables the conversion of outstanding receivables into cash flows.5. Factoring involves an outright sale of book debts to the factor by the client.6. Factor makes an advance payment (generally ranging from 80% to 90%) against the invoicesfactored by the client firm.7. Factor may assume the credit risk (without recourse factoring), or may not assume the creditrisk (with recourse factoring) arising from the collection of receivables.8. In addition to financing through the advance payment, the factor undertakes the services of

credit collection, sales ledger maintenance, etc.

Legal aspects of factoring by V S Rama Rao on January 25, 2009


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Factoring contract is like any other sale- purchase agreement regulated under the law of contract.There is no codified legal framework / code to regulate factoring services in India. The legalrelationship between a factor and a client is largely determined by the terms of the factoringcontract entered into before the factoring process starts. Some of the contents of a factoringagreement and legal obligations of the parties are listed as follows:

(1) The client gives an undertaking to sell and the factor agrees to purchase receivablessubject to terms and conditions mentioned in the agreement.(2) The client warrants that the receivables are valid enforceable, undisputed andrecoverable. He also undertakes to settle disputes, damages and deduction relating to the

bills assigned to the factor.(3) The client agrees that the bills purchased by the factor on a non-recourse basis (i.e.approved bills) will arise only from transactions specifically approved by the factor or those falling within the credit limits authorized by the factor.(4) The client agrees to serve notices of assignments in the prescribed form to all thosecustomers whose receivables have been factored.

(5) The client agrees to provide copies of all invoices, credit notes, etc., relating to thefactored accounts, to the factor and the factor in turn would remit the amount receivedagainst the factored invoices to the client.(6) The factor acquires the power of attorney to assign the debts further and to drawnegotiable instruments in respect of such debts.(7) The time frame for the agreement and the mode of termination are specified in theagreement.(8) The legal status of a factor is that of an assignee. The customer has the same defenseagainst the factor as he would have against the factor as he would have against the client.(9) The customer whose account has been factored and has been notified of theassignment is under legal obligation to remit the amount directly to the factor failingwhich he will not be discharged from his obligation to pay the factor even if he paysdirectly to the client remits the amount to the factor.(10) Before factoring a receivable, the factor requires a letter of disclaimer from the bank which has been financing the book debts through bank finance to the effect that from thedate of the letter the bank can not create a charge against the receivables i.e. the bank willnot provide post-sales finance as the factor provides.(11) Priority over other claimants to book debts: It will be extremely important for thefactor to make sure that the book debts it handles are free from any encumbrances whichwould entitle someone else to the money due. The firm has to guarantee that the book debts are free from any rights of a third party in the factoring agreement.(12) Other powers: The factor has sometimes to act quickly to recover money due on aninvoice. A customer with money outstanding to the factor may be in difficulty and naydelays in acting could see the money gone forever. The agreement must provide for thefactor to act swiftly in his name, whenever necessary.(13) The factoring agreement sets out in detail how the firm s to be paid.(14) Approved and unapproved debts: The attraction of factoring for many companies isthat non-recourse factoring can give a degree of insurance against the customer who doesnot pay. This depends on whether the debt is approved or not, which is decided before thefactoring process starts.


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(15) Where the factor may reclaim money already advanced. Factoring agreements provide for payment by the customer directly to the factor. If any of the customers pay itto the client by mistake, the agreement provides that the firm must hold the money for thefactor. If he does not do so, this is effectively a breach of trust and the firm may be heldresponsible for any losses incurred by the factor.

(16) Warrants Some warrants that are required are:(a) The firm should disclose any materials facts that it knows might affect the factorsdecision to approve a debt.(b) It has to warrant that the invoices sent for factoring represents a proper debt for goodssupplied.(17) Disputed debts: The factor may require the customer to notify it immediately in caseof disputed debts. The firm may be expected to return any advances made to it in respectof the disputed debt.(18) The factors power to inspect the firms books and accounts and the period of thefactoring arrangements is usually laid down in the agreement.

Factoring in India Wh at is factoring?

Factoring is a financial option for the management of receivables. In simple definition it is theconversion of credit sales into cash. In factoring, a financial institution (factor) buys the accountsreceivable of a company (Client) and pays up to 80%(rarely up to 90%) of the amountimmediately on agreement. Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when the customer pays the debt. Collection of debtfrom the customer is done either by the factor or the client depending upon the type of factoring.

We will see different types of factoring in this article. The account receivable in factoring caneither be for a product or service. Examples are factoring against goods purchased, factoring for construction services (usually for government contracts where the government body is capable of

paying back the debt in the stipulated period of factoring. Contractors submit invoices to getcash instantly), factoring against medical insurance etc. Let us see how factoring is done againstan invoice of goods purchased.


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C h aracteristics of factoring

1. U sually the period for factoring is 90 to 150 days. Some factoring companies allow evenmore than 150 days.

2. Factoring is considered to be a costly source of finance compared to other sources of

short term borrowings.3. Factoring receivables is an ideal financial solution for new and emerging firms withoutstrong financials. This is because credit worthiness is evaluated based on the financialstrength of the customer (debtor). Hence these companies can leverage on the financialstrength of their customers.

4. Bad debts will not be considered for factoring.5. Credit rating is not mandatory. But the factoring companies usually carry out credit risk

analysis before entering into the agreement.6. Factoring is a method of off balance sheet financing.7. 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 vary from

1.5% to 3% per month depending upon the financial strength of the client's customer.8. Indian firms offer factoring for invoices as low as 1000Rs9. 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 monthand 2% afterwards).

D ifferent types of Factoring

Factor

Client Customer

Pays the amount (In recourse typecustomer pays through client)

credit sale of goods

Invoice

Submit invoice

copy

Payment up to80% initially

Pays the balanceamount


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1. Disclosed and U ndisclosed2. Recourse and Non recourse

A single factoring company may not offer all these services.

Disclosed

In disclosed factoring client's customers are notified of the factoring agreement. Disclosed typecan either be recourse or non recourse.

Undisclosed

In undisclosed factoring, client's customers are not notified of the factoring arrangement. Salesledger administration and collection of debts are undertaken by the client himself. Client has to

pay the amount to the factor irrespective of whether customer has paid or not. But in disclosedtype factor may or may not be responsible for the collection of debts depending on whether it is

recourse or non recourse.

Recourse factoring

In recourse factoring, client undertakes to collect the debts from the customer. If the customer don't pay the amount on maturity, factor will recover the amount from the client. This is the mostcommon type of factoring. Recourse factoring is offered at a lower interest rate since the risk bythe factor is low. Balance amount is paid to client when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts from the customer. Balanceamount is paid to client at the end of the credit period or when the customer pays the factor whichever comes first. The advantage of non recourse factoring is that continuous factoring willeliminate the need for credit and collection departments in the organization.

Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com

SBI Factors and Commercial S ervices Pvt. Ltd : http://www.sbifactors.com

Th e Hongkong and S h ang h ai B anking Corporation Ltd : http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services

Foremost Factors Limited : http://www.foremostfactors.net

G lobal T rade Finance Limited


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factoring process

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