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Business Factoring

Meaning and Scope:

Factoring is a continuing arrangement between a financial institution and a business concern selling goods and services to trade customers. As a result of this arrangement, the factor undertakes collection of the clients debts and finance to client on the basis of his accounts receivable.

However, the scope of factoring in modern times has considerably increased. It is a continued service arrangement under which a financial institution undertakes the task of recording, collecting, controlling and protecting the book debts for its clients including the purchase of his bills receivable. Thus, as a result of factoring services, the manufacturers, seller or dealer in goods can concentrate on manufacturing, advertising and selling functions alone, the record keeping functions of sales, book debts, bills receivable and their utilization are completely vested with the factoring agency. The results are the following major benefits to the client.

i) Reduction in the cost of maintenance and collection of book debts.

ii) Saving in time, manpower needed for collection, and

iii) Monitoring of book debts and prevention of bad debts, since the debtors would not like to be looked down in the eyes of factoring credit institution.


The functions of a factoring credit institution can be grouped in the following categories:

i) Credit recording It involves maintenance of debtors ledger, collection schedules, discount allowed schedule, ascertainment of balance due.

ii) Credit administration It includes the work of collecting the book debts. The factoring institution receives service charges by way of discount or rebate deducted from the bill or bills.

iii) Credit protection The factoring institution eliminates the risk of loss of the client by taking over the responsibility of book debts due to the client.

iv) Credit financing The factoring institution advances a proportion of the value of book debts of the clients immediately and the balance on maturity of book debts. This improves the clients liquidity position in the sense that book debts have been substituted by cash.

v) Finance and business information A factoring institution also advises the client on the prevailing business trend, financial and fiscal policy, impending development in commercial and industrial sector, potentials for foreign collaboration, transfer of technology, export and import potential, identification and selection of potential trade debtors.

Types of Factoring:

The factoring services can be of the following types:

1. Recourse factoring In the case of recourse factoring the firm bears the credit risks inherent in the receivables assigned to the factor. In other words, the firm is liable for any bad debts incurred.

2. Non-recourse factoring In the case of non-recourse factoring, the factor besides providing assistance for collection also assumes the risk of bad debts. However, under non0recourse factoring also, an enterprise retains the right of recourse against the factor if the customer fails to pay for any reason other than financial distress.

3. Advance factoring In the case of advance factoring, the factor provides an immediate advance against the receivables assigned to it.

4. Maturity factoring In the case of maturity factoring, the factor provides an assistance as regards collection and possible insurance against bad debts.

5. Bank participation factoring In case of an ordinary factory arrangement, a certain percentage of the face value of receivables is set aside by the factor as reserve to protect against sales returns or cash discount. For instance, if the receivables are of Rs.100, the factor after keeping the reserve of about 10% will grant advance only against the balance of receivables. In other words, the banker will advance only Rs. 90 to the firm. In case of participation factoring, the firm creates a floating charge in favour of commercial bank and borrows against such reserve.

6. Supplier guarantee factoring In the case of supplier guarantee factoring, the factor provides a guarantee to the supplier against the invoice raised by the supplier on the firm. The firm raises the bills on the ultimate customers and assigns them to the factor. This arrangement is advantageous to both the supplier and the firm since the factor takes care of the collection of bills of both the parties.

7. Disclosed factoring In case of this type of factoring the name of the factor is mentioned or disclosed in the sales invoice. In a reverse case it is termed as undisclosed factoring.

8. International factoring It refers to factoring of export sales. An international factoring house, in addition to the usual service of a factor also undertakes the responsibility of completing of all legal and procedural formalities concerned with the export sales. The firm is, therefore, saved from the trouble of getting itself involved in the intricacies associated with the international trade.

Factoring Services in India:

There are at present two factoring companies operating in India. They are State Bank of India (SBI) Factors and Commercial Services Ltd., a subsidiary of SBI and Can Factors Ltd., a subsidiary of Canara Bank. The SBI factors with its corporate office at Mumbai, has jurisdiction over Maharashtra, Gujarat, Madhya Pradesh and Goa, Daman & Diu and Can Factors Ltd., with its corporate office at Bangalore has jurisdiction over the Southern States.

The working procedure involved in the factoring services as adopted by SBI Factors and Commercial Services Ltd., can be summarized as follows:

i) The supplier invoices his customers in the usual way only adding the notification that the debt due on the invoice is assigned to and must be paid to the SBI Factors.

ii) The supplier offers assigned invoices to the SBI Factors with a schedule of offer accompanied by the receipted delivery challans.

iii) The SBI Factors provide pre-payment to the supplier upto 80 per cent of the invoice value. It also performs the accounting function of sales ledger maintenance and the collection function of realizing invoices purchased.

iv) The SBI Factors sends an official notification and personalized statement of accounts to different customers of the supplier.

v) On receipt of payment from the customers, the SBI Factors pays the remaining 20 per cent of the invoice value to the supplier.

vi) In order to keep the supplier informed of the factored invoices, the SBI factors send monthly statement of accounts to the supplier.

Service Fee:

A service fee is levied for the work involved in maintaining sales ledger and collection of the debts due on the invoices. It will be calculated as a percentage of the gross value of the invoices factored, based on (a) the gross sales volume (b) the number of customers (c) the number of invoices and credit notes, and (d) work involved in collections. The service fee ranges between two and five per cent of the gross value of the invoices.

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