Factoring is commonly identified as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Factoring service is a service that covers (i).Collection of bills, (ii).discounting of bills (iii).maintenance of accounts books in domestic and international trade. Factoring enables companies to sell their outstanding book debts for cash. They sell invoiced receivables at a discount to the factor to raise finance for working capital requirement. Under the domestic factoring the payment of the bills that the seller gets from the factor is nearly 80 per cent of the bill amount upon tendering the bill and the balance on due date after collecting it from the buyer.
The type of factoring may be ‘with recourse’ or ‘without recourse’ arrangement which depends upon whether the factor is ready or not ready to accept the incumbent credit risk. The type of factoring under which the factor collects back from the seller/supplier the amount paid by him, in case of non-payment of the bills on the due date is called ‘Recourse factoring’. The term ‘Without recourse’ means that the seller has no further interest in the transaction. It is the factor who collects the future payments due from the buyer and it is the factor that runs all the risks of non-payment, as he cannot claim the payment back from the seller.
The supplier company (seller) and the factor will enter into an agreement for assigning the debts of the buyer/purchaser of the goods to the factor. The factor makes advances only against invoices drawn on particular purchaser of goods. If there are more than one buyer where debts to be assigned to factor, sub-limit of each buyer is fixed within the overall limit. The credit limit is fixed on the basis of projected sales on credit, and deducting existing bills and Cash Credit limit against book debts enjoyed by the party from the bank. The fixation of limit needs proper working capital appraisal and debtor ageing analysis. The maximum debt period normally permitted under factoring is 150 days inclusive of a maximum grace period of 60 days.
The interest rate on bills purchased/discounted is based on credit rating and interest rate of money market. In addition to the interest factor would collect handling charges for the transaction, including follow up, administration charges etc.
Factoring has many advantages to a seller. By obtaining payment of the invoices immediately from the factor, which will be usually up to 80% of their value, the company’s cash flow is improved. Once the bill is discounted, the factor then takes over responsibility for claiming the debt from the buyer.
Related topics
What is international factoring?
What is the difference between factoring and forfaiting?
