Factoring (Financial Services),

FACTORING

CHAPTER 1 INTRODUCTION TO FACTORING Factoring is a type of financial service provided by the specialist organizations. When small scale firms sell on credit basis, collection of receivable poses a problem. In that case factoring organizations play an important role in collection of debtors. Factoring involves sale of receivables to specialized firm, called factors. Factors collect receivables and also advance cash against receivables to solve the client firm’s liquidity problem. For providing their services, they charge interest on advance and commission for other services. In other words, factoring is an arrangement under which a financial institution (called factor) undertakes the task of collecting the book debts of its client in return for a service charge in the form of discount or rebate. The factoring institution eliminates the client’s risk of bad debts by taking over the responsibility of book debts due to the client. The factoring institution advances a proportion of the value of book debts of the client immediately and the balance on maturity of book debts.

DEFINITION “Factoring is a service involving the purchase by a financial organization, called a factor, of receivables owned to manufacturer and distributors by their customers, with the factor assuming full credit and collection responsibilities.” “Factoring is a service of financial nature involving the conversion of credit bills into cash.”

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FACTORING

CHARACTERISTICS OF FACTORING  Usually the period for factoring is 90 to 150 days. Some factoring companies allow even more than 150 days.  Factoring is considered to be a costly source of finance compared to other sources of short term borrowings.  Factoring receivables is an ideal financial solution for new and emerging firms without strong financials. This is because credit worthiness is evaluated based on the financial strength of the customer (debtor). Hence these companies can leverage on the financial strength of their customers.  Bad debts will not be considered for factoring.  Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement.  Factoring is a method of off balance sheet financing.  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 varies from 1.5% to 3% per month depending upon the financial strength of the client's customer.  Indian firms offer factoring for invoices as low as 1000Rs  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 month and 2% afterwards).

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FACTORING

MECHANISM

A factor provides finance to his client upto a certain percentage of the unpaid invoices which represent the sales of goods or services to approved customers. The mechanism of the factoring scheme is as follows:  There should be a factoring arrangement (invoice purchasing arrangement) between the client (which sells the goods and services to trade customer in credit) and the factor, which is the financing organization.  Whenever the client sells goods to the trade customers on credit he prepares invoices in the usual way.  The goods are sent to the buyers without raising a bill of exchange but accompanied by an invoice.  The debt due by the purchaser to the client is assigned to the factor by advising the trade customers to pay the amount due to the client, to the factor.  The client hands over the invoices to the factor under cover of a schedule of offer along with the copies of invoices and receipted delivery challans.  The factor makes an immediate payment upto 80% of the assigned

invoices and the balance 20% will be paid on realization of the debt.

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FACTORING

Customer

credit sale of goods

Client

Invoice

Pays the balance amount

Pays the amount (In recourse type customer pays through client)

Submit invoice copy

Payment up to 80% initially

Factor

TERMS AND CONDITIONS  Assignment of debt in favor of the factor,  Selling limits for the client,  Conditions within which the factor will have recourse to the client in case of non-payment by the trade customer,  Circumstances under which the factor

for his services, say for

instance, as a certain percentage on turnover,  Interest to be allowed to the factor on the account where credit has been sanctioned to the supplier, and  Limit of any overdraft facility and the rate of interest to be charged by factor.

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FACTORING

CHAPTER 2 TYPES OF FACTORING

o Recourse and Non-recourse Factoring

Under a recourse factoring arrangement, the factor has recourse to the client (firm) if the debt purchased/receivables factored turns out to be irrecoverable. If the customer defaults in payment, the client has to makes good the loss incurred by the factor. The factor charges the client for maintaining the sales ledger and debt collection services and also for the interest for the period on the amount drawn by the client. The factor does not have the right of recourse in the case of non-recourse factoring. The loss arising out of irrecoverable receivables is borne by him, as a compensation which he charges a higher commission. o Advance and Maturity Factoring

A drawing limit, as a pre-payment, is made available by the factor to the client as soon as the factored debts are approved. The client has to pay interest on the advance between the date of such payment and the date of actual collection from the customers. The maturing factoring is also known as Collection factoring. Under such arrangements, the factor does not make a pre-payment to the client. The payment is made either on the guaranteed payment date or on the date of collection.

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FACTORING

o Full Factoring

This is the most comprehensive form of factoring combining the features of almost all the factoring services specially those of non-recourse and advance factoring. Full factoring provides the entire spectrum of services (collection, credit protection, sales ledger administration and short term finance). o Disclosed and Undisclosed Factoring

In disclosed factoring, the name of the factor is disclosed in the invoice by the supplier-manufacturer of the goods asking the buyer to make payment to the factor. The supplier may continue to bear the risk of non-payment by the buyer without passing it on to the factor. The name of the factor is not disclosed in the invoice in undisclosed factoring although the factor maintains the sales ledger of the supplier manufacturer. The entire realization of the business transaction is done in the name of Supplier Company but all control remains with the factor. He also provides short-term finance against sales invoice. o Domestic and Export/Cross-Border/International Factoring In the domestic factoring, the three parties involved, namely, customer(buyer), client(seller-supplier) and factor (financial intermediary) are domiciled in the same country. The process of export factoring is almost similar to domestic factoring except in respect of the parties involved. There are usually four parties involved in cross-border factoring transaction. They are: exporter (client), importer (customer), export factor and import factor. Page | 6

FACTORING

CHAPTER 3 FUNCTIONS OF A FACTOR  Administration of sales ledger The factor maintain sales ledger in respect of each client when the sales transaction takes place an invoice is prepared in duplicate by the client, One copy is given to customer and second copy is sent to the factor. Entries are made in the ledger on open item method. Each receipt is matched against the specific invoice. On any given date the customer account indicate the various open invoices outstanding. Periodic reports are sent by factor to the client with respect to current status of transaction the periodicity of report is decided. Thus the entire sales ledger administration responsibility of the client gets transferred to factor.  Collection of Receivables The main function of the factor is to collect the receivable on the behalf of the client and to relieve him from all the botherations problems associated with the collection. This way the client can concentrate on other major areas of his business on one hand and reduce the cost of collection by way of saving in labour time and efforts on the other hand. The factor possesses trained and experienced personal, sophisticated infrastructure and improve technology which helps him to make timely demands on the debtors to make payments.

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FACTORING

 Provision of Finance Finance which is the life blood of a business, is made available easily by the factor to the client. A factor purchased the book debts of his client and debts are assigned in favour of the factor. Around 75% to 80% of the assigned debts are given as advance to the client by the factor.  Protection Against Risk This services is provided where the debts are factored without resources. The factor fixes the credit limit in respect of approved customers. Within this limit the factor undertakes to purchase all trade debts and assumes risk of default in payment by the customers. The factor not only relives the client from the collection work but also advises the client on the creditworthiness of potential customers. Thus the factor helps the client in adopting better credit control policy. The credit standing of the customers is assessed by the factors on the basis of information collected from credit rating reports, bank reports, trade reference, financial statement analysis and by calculating the important ratios in respect of liquidity and probability position.  Advisory Services These services arise out of the close relationship between a factor and a client. Since the factor have better knowledge and wide experience in field of finance, and possess extensive credit information about customers standing.

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FACTORING

They also, provide various advisory services on the matters relating to:  Customer’s preferences regarding the client products.  Changes in marketing polices of the competitors  Suggest improvements in the procedures adopted for invoicing, delivery and sales return.  Helping the clients for raising finance from banks /financial institutions, etc.

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FACTORING

CHAPTER 4 THE HISTORY OF FACTORING Factoring has a long and rich tradition, dating back 4,000 years. The Mesopotamians used factoring in their business dealings. Almost every civilization that valued commerce has practiced some form of factoring, including the Romans who were the first to sell actual promissory notes on a secondary market at a discount. Factoring gained true popularity, however, in trade between the American colonists and their European buyers. Prior to the American Revolution, merchants in the colonies sent raw materials, from timber to wool to cotton to furs, to British and European merchants. However, sending the goods such long distances could get expensive. And in the meanwhile, waiting for payment to come back across the Atlantic from Britain and Europe could cause delays in being able to do what was necessary to harvest and plant and process new orders. In order to get around these problems, the British and European merchants paid the colonists in part for the materials. This way, the colonists had an advance with which to continue their operations. These eased cash flow and created a streamlined process for ensuring that trade continued unabated. As society progressed after the American Revolution, and as the Industrial Revolution came, the focus of factoring changed. Credit became more important to factoring. The credit of the company itself was not as important as the credit of its clients. Indeed, in many cases, factors helped companies figure out which of its customers were the most credit worthy. This way, Page | 10

FACTORING

factors could also help companies keep their cash flow moving. They advanced companies capital based on what was owed them by their credit worthy customers. Before the 1930s, the most popular industries for factoring were the garment and textile industries. These are industries that rely on raw materials. In order to make sure that companies could continue to buy raw materials to produce clothing and textiles, factoring was used. However, it soon became evident, after World War II, that factoring could work effectively for any business that invoiced others. During the 1960s, 1970s and 1980s, interest rates were on the rise and banks were increasingly regulated. This made it difficult for companies to get traditional financing. Factoring became even more popular, since it did not require the same sort of credit checks. Additionally, since the invoices were bought – deducting the fees – it was possible to avoid the some sort of interest charges. Small business, startups and rapidly growing businesses benefitted especially from this increase in factoring. Factoring grew as a service as business people found their options contracting. Today, factoring remains a viable alternative to more traditional financing. Thousands of businesses sell their accounts receivable to factors every year – amounting to an industry representing billions of dollars. And nearly any business with reliable customers and an invoicing system can take advantage of factoring

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FACTORING

CHAPTER 5 FACTORING SERVICES IN INDIA

Factoring services had been introduced since 1991 in India, but still it is quite new in the sense that factoring product is not widely known in many parts of the country. Recognizing the utility of factoring services for small and medium size industrial and commercial enterprises in India, for the first time the Vaghul Committee which submitted its report on the Money Market, recommended the development of a system of factoring of open account sales particularly for the small scale industrial units. This committee further observed that both banks and non-bank financial institutions in the private sector should be encouraged to set up institutions for providing factoring services. Later, the Kalyanasundaram Committee, which was appointed by the Reserve Bank of India (RBI) in 1988 specifically for exploring the possibilities of launching factoring services in India, found an abundant scope for such services and hence strongly advocated for the introduction of factoring services in India. This committee also observed that banks were ideally suited for providing factoring services to the industries in the economy. However, the said Committeeexpressed the view that to begin with only four or five banks either individually or jointly should be allowed on zonal basis to undertake factoring services. The recommendations of Kalyanasundaram Committee were accepted by the RBI. Subsequently a suitable amendment was made in the Banking Regulation Act 1949, so as to allow banks to set up subsidiary company for undertaking factoring services.

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FACTORING

To begin with, the RBI permitted both the State Bank of India and Canara Bank to start factoring services through their own subsidiaries. Accordingly, two factoring companies in India, i.e. SBI Factors and Commercial Services Ltd. and Canbank Factors Ltd; sponsored by the State Bank of India and Canara Bank respectively, commenced operations in 1991. In the beginning they were allowed to operate in Western and Southern Zone of India respectively. However, later on, the RBI lifted these area restrictions on their operations and accordingly, both these companies were given permission to expand and operate their business in other parts of the country. In view of this, they can operate on all-India basis. In 1993 the RBI allowed all the scheduled commercial banks to introduce factoring services either departmentally or through a subsidiary set-up. Besides SBI Factors and Commercial Services and Canbank Factors Ltd., there are a few non-banking finance companies such as Formost Factors Ltd., Global Trade Finance Pvt. Ltd. (a subsidiary of EXIM Bank) and Integrated Financial Services Ltd., which are also in the business of domestic factoring in India. Of these, Global Trade Finance Pvt. Ltd. and Formost Factors Ltd. have undertaken the business of export factoring also. Besides

these

non-banking

finance

companies,

Small

Industries

Development Bank of India (SIDBI), Hongkong and Shanghai Banking Corporation have been offering factoring services to their clients. Almost all of them have been providing factoring services to the SSI and non-SSI units.

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FACTORING

Factoring Companies in India o Canbank Factors Limited o SBI Factors and Commercial Services Pvt. Ltd o The Hongkong and Shanghai Banking Corporation Ltd o Foremost Factors Limited o Global Trade Finance Limited o Export Credit Guarantee Corporation of India Ltd o Citibank NA, India o Small Industries Development Bank of India (SIDBI) o Standard Chartered Bank

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FACTORING

CHAPTER 6 DOMESTIC FACTORING Overview Like International Factoring, in domestic factoring invoices are raised on open account sale of goods and are assigned to SBIGFL for financing, collection, and sales ledger administration. Product features 

Financing the seller by prepaying upto 90% of the invoice value/ Bill value



Protection against default in payment by the buyer by arranging for insurance cover



Collection of receivables



Maintenance of accounts relating to accounts receivables (A/R)

Characteristics of factorable transactions Domestic Receivables that can be factored should have the following characteristics: 

The seller’s performance obligations should be completed at the time the seller presents an invoice for prepayment.



There should be multiple shipments or a continuous sales flow on an ongoing basis with the same buyer or buyer(s).



Factoring transactions necessarily require credit terms and are best suited for credit periods of upto 120 days. However, factoring transactions can also be structured for credit sales for upto 180 days. Page | 15

FACTORING 

LC's are not required



Factoring facilities are typically provided for "open account" transactions and can also be structured for transactions involving negotiable instruments such as bills of exchange or promissory notes, on a case to case basis.

Factoring, necessarily, requires the assignment of whole turnover with a buyer. Hence, all credit sales to a buyer have to be assigned to SBIGFL on a continuous

basis

once

the

factoring

arrangement

is

in

place

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FACTORING

CHAPTER 7 INTERNATIONAL FACTORING Overview The use of the Factor/Agent grew throughout the Middle Ages. During the period of colonization by European countries from the sixteenth century onwards, exporters of consumer goods from Europe sought the help of these mercantile Agents or Factors to promote their trade. The concept spread across the Atlantic and grew rapidly in the United States, as there was a significant demand for European merchandise. The services of the Factors during that period usually included the following: 

Taking physical possession of the goods on consignment



Storing them



Finding buyers and delivering the goods to them



Collecting payment from the buyers

From its humble origin, factoring has come a long way today. It has gained lot of prominence and acceptance and is being offered as a valuable financial product among major financial institutions and banks.

International factoring International factoring is a comprehensive receivable management service encompassing finance, credit protection, collection and sales ledger management for exports on open account terms.

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FACTORING

Product features 

Finance to the exporter by prepaying upto 95% of the invoice value



Protection against default in payment by the buyer by arranging for credit cover



Collection of receivables



Maintenance of accounts relating to accounts receivables (A/R)



LC's are not required

Characteristics of Factorable Exports Export Receivables that can be factored should have the following characteristics: 

Buyer's country should be acceptable.



The exporter's performance obligations should be completed at the time the exporter presents an invoice for prepayment. Performance under turnkey contracts involving execution or commissioning of equipment is usually not factorable.



There should be multiple shipments or a continuous sales flow on an ongoing basis with the same buyer or buyer(s).



LC's are not required



Factoring transactions necessarily require credit terms and are best suited for credit periods of upto 120 days. However, factoring transactions can also be structured for credit sales for upto 180 days.



Factoring

facilities

are

typically

provided

for "open

account" transactions and can also be structured for transactions involving negotiable instruments such as bills of exchange or promissory notes, on a case to case basis. Page | 18

FACTORING 

Factoring

necessarily

requires

the assignment

of

whole

turnover with a buyer.

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FACTORING

CHAPTER 8 IMPORT FACTORING Import factoring is a financial service that enables you to purchase goods from your overseas supplier on short term credit of upto 180 days on open account terms without the need for opening a letter of credit (LC). As an importer, you will receive credit from your overseas suppliers without incurring any additional cost charged to a factor like SBIGFL. Your primary obligation would be to make payment to the Factor on the due date. Imports that can be Factored As Import Factoring covers imports upto 180 days, generally import of raw materials and intermediates can be covered.

To Use Import Factoring You have a supplier who insists on an LC to be opened or needs some other assurance of payment. If an LC is opened, you tie up cash credit limit with your bank apart from incurring costs for opening the LC. Import Factoring is a new alternative to opening of an LC. As a result, your supplier will be able to offer open account trading to you combined with his need for the credit risks to be covered.

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FACTORING

Working of Import Factoring Import factoring works on a two factor platform. Your supplier approaches an Export Factor in his country and requests for a credit line on you. The Export Factor applies to the Import Factor for collection and due date payment services and evaluation of credit risk on you. We grant a credit line to the Export Factor on evaluation of your Company. Credit line means a credit risk evaluation up to the specific amount and refers to buyer insolvency or inability to pay. As soon as the factoring agreement is concluded between the supplier and the Export Factor, you can start to purchase the goods from your supplier on open account terms without opening a LC. On due date, you will pay the amount against full discharge of your liability.

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FACTORING

CHAPTER 9 SBI GLOBAL FACTORS LTD Background SBI Factors was established in February, 1991 with the primary objective of providing domestic factoring services to Small and Medium Enterprises (SME). SBI Factors was merged with GTF w.e.f. February 11, 2010 to form SBI Global Factors Ltd (SGFL). SGFL is the largest factoring company in India and is the

only provider of

international factoring, domestic factoring and forfaiting services under one roof along with value added services to its clients. Management The SBI group remains the major shareholder (85%) post merger which is a comforting factor for the credit profile of SGFL. SBI has deputed senior management personnel appointed senior management on the Board of Directors and key management positions of SGFL. Mr. Pratip Chaudhari (Chairman, SBI) is the Chairman of SGFL. In addition to the management, SBI has also extended support through its brand and logo to be associated with SGFL. This highlights the strategic importance of SGFL to the SBI group and SBI is expected to provide management as well as operational and financial support from financial support to SGFL.

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FACTORING

Asset Profile SGFL offers various products under factoring like, Domestic Factoring, Export Factoring, Import Factoring and Factoring against Letter of Credit (LC). SGFL had total turnover of Rs.12, 978 crore during FY10 as compared to Rs.18,282 crore (standalone GTF). Majority of the turnover (64%) was in domestic factoring followed by factoring against LC. A product wise break up of turnover is given below: Products

FY09*

%

FY10*

%

H1FY11*

%

Domestic Factoring

12,180

67

6,203

48

2,524

64

Receivable Factoring

2,292

13

1,092

8

374

9

Export Factoring

435

2

1,142

9

444

11

Import Factoring

1,121

6

38

0

8

0

Funding against LC

2,255

12

4,502

35

601

15

TOTAL

18,282

100

12,978

100

3,951

100

* Figures for FY09 are for GTF and that for FY10 and H1FY11 are for merged entity and hence not directly comparable During H1FY11, turnover was moderate at Rs.3951 crore as the focus of the management is to have controlled growth to improve the asset quality of the portfolio.

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FACTORING

Asset Quality SGFL has major exposure to SME sector which led to sharp deterioration in its asset quality during FY09 and FY10 as the sector was impacted due to economic slowdown. SGFL had slippages in few large value exposures due to which it reported Gross NPAs of Rs.635 crore and Net NPA of Rs.507 crore as on March 31, 2010. SGFL’s Gross NPA ratio stood at 20.96% while net NPA to Net worth ratio stood high at 97.14% as on March 31, 2010. Majority of the NPAs were observed in the reverse factoring and import factoring products which had higher proportion in GTF’s portfolio as compared to that of SBI Factors. Currently, SGFL is focused only on domestic factoring and has decreased the exposure in other products. It has also taken stringent steps to improve its underwriting process and standards to improve the asset quality. SGFL is also in the process of providing and writing off its portfolio to clean its balance sheet. Increase in provisioning and write-off cost is likely to have severe impact on profitability and capital adequacy of SGFL in the next two years. Improvement in asset quality would remain a key rating sensitivity for SGFL.

Resources Profile Resources profile is characterised by high dependence of SGFL on market borrowings and bank finance. Net worth constituted around 17% of total liabilities as on March 31, 2010. Since the average tenor of receivables is low (90 to 120 days) majority of the borrowings as on March 31, 2010 were short term borrowings from banks (comprising 57% of total borrowings). However, during H1FY11, due to change to base-rate scenario, SGFL’s cost of borrowing from banks increased due to which it moved towards market borrowings through issue of Commercial Paper (CP) which constituted 50% Page | 24

FACTORING

of total borrowings as on September 30, 2010. SGFL, reported Capital Adequacy Ratio of 19.88% as on March 31, 2010. However, considering the deterioration in the asset quality, capital support from parent company may be required and would be a key rating sensitivity.SBI has infused Rs.50 crore into SGFL during March, 2011 as capital.

Financials The merger of SBI Factors and GTF took place with effect from February 11, 2010. The appointed date for the merger is April 1, 2009. Financials for FY10 were the first set of accounts of SGFL. During FY10, SGFL reduced its operations to prevent further deterioration in asset quality thereby resulting into lower income. SGFL reported total income of Rs.493 crore during FY10 as compared to income of Rs.512 crore (of standalone GTF) during FY09. It reported Profit After Tax (PAT) of Rs.7 crore during FY10. During the year, SGFL reported provision and write-off of NPAs amount ting to Rs.242 crore which severely impacted the profitability of the company. However, the operating level profitability remained good. Overall gearing was moderate at 4.94 times whereas interest coverage stood low at 1.1x as on March 31, 2010.

Performance for H1FY11 During H1FY11, SGFL saw moderate portfolio growth with majority of the portfolio being towards domestic factoring. It reported total income of Rs.132 crore for the period. During H1FY11, it made provision and write-off on NPAs of Rs.114 crore which resulted in SGFL reporting loss of Rs.49 crore for H1FY11.

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FACTORING

CHAPTER 10 ADVANTAGE AND DISADVANTAGE OF FACTORING

BENEFITS OF FACTORING There are many benefits to companies that choose to factor. In Addition to avoiding all the paper work associated with obtaining traditional financing, factoring is easy and generally provides instant cash. Below is a list of additional benefits of factoring: o Receive an Influx of Working Capital The primary benefit of factoring is that it helps your business get the working capital it needs without taking on new debt or diluting ownership of your company by bringing in new investors. Because today's economic environment is highly competitive, many businesses are under immense pressure to improve operations and undertake cost cutting measures in order to stay profitable. These problems are compounded for small businesses becasue most small businesses are often times understaffed to begin with. As a result, owners of small businesses frequently spend more time on cash flow and customer credit issues rather than on their primary objectives of growing their business, increasing sales, managing marketing campaigns and improving employee productivity. Many small businesses experience serious cash flow problems because their cash is tied up in their accounts receivable. For businesses that are growing, the cash flow problems can be even worse because more and Page | 26

FACTORING

more of their capital is not in their bank account, but is on the balance sheet as receivables. Most businesses want to grow and expand, but if appropriate planning is not done, an entire business will feel the squeeze because it is undercapitalized. Invoice factoring is a solution to free up your capital and have it available when you need it. Your business will be able to invest resources in areas where it can help you become more profitable, such as payment discounts or taking advantage of promtional prices for inventory or supplies. o Improve Cash Flow Without Borrowing From a Bank It can eliminate long billing cycles and receive cash for outstanding invoices generally within 48 hours of less. Since factoring is not a loan, it take on no new debt and maintain company's leverage to take on new debt in the future. o Capitalize on Supplier Discounts Many suppliers offer discounts if they are paid in a short period of time. By factoring, accelerate cash flow allowing to pay suppliers earlier and take advantage of supplier discounts or buy in larger quantities. o Build or Repair Credit Rating and Credit Score Since factoring will give an immediate cash, it can pay the bills on time, or possibly even early, allowing to build or repair credit rating. Improving your credit rating and raising your credit score will give you increased borrowing power.

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FACTORING

o Secure Capital By Leveraging Assets Factor is based on the credit worthiness of customers, you can get the cash business needs by leveraging outstanding receivables. ADVANTAGES

Benefits of Factoring to Clients o Under the factoring arrangement the client receives prepayment upto 80-90 percent of the invoice value immediately and the balance amount after the maturity period. This helps the client to improve cash flow position which enables him to have better flexibility in managing working capital funds in an efficient and effective manner. o If the client avails the services of the factor in respect of sales ledger administration and collection of receivables, he need not have any administrative set up for this purpose. Naturally this will result into a substantial saving in time and cost of maintaining own sales ledger administration and collecting receivables from the customer. Thus, it will reduce administrative cost and time. o When without recourse factoring arrangement is made, the client can eliminate the losses on account of bad debts. This will help him to concentrate more on maximizing production and sales. Thus, it will result in increase in sales, increase in business and increase in profit. o The client can avail advisory services from the factor by virtue of his expertise and experience in the areas of finance and marketing. This will help the client to improve efficiency and productivity of his organization. Besides this, with the help of data base, the factor can Page | 28

FACTORING

readily provide information regarding product design/mix, prices, market conditions etc., to the client which could be useful to him for business decisions. The above mentioned benefits will accrue to the client provided he develops a better business relationship with the factor and both of them have mutual trust in each other.

DISADVANTAGES o Image of the client may suffer as engaging a factoring agency is not considered a good sign of efficient management. o Factoring may not be of much use where companies or agents have one time sales with the customers. o Factoring increases cost of finance and thus cost of running the business. o If the client has cheaper means of finance and credit (where goods are sold against advance payment), factoring may not be useful.

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FACTORING

CHAPTER 11 CASE STUDY OF SUNLIGHT INDUSTRIES LTD. Sunlight Industries Ltd. manages its account receivables by its sales and credit department. The cost of sales ledger administration stands at Rs. 9 crore annually. It supplies chemicals to heavy industries. These chemicals are used as raw material for further use or are directly sold to industrial units for consumption. There is a good demand for both the types of uses. For the direct consumers, the company has a credit policy 2/10, net 30. Past experience of the company has been that on avg. 40% of the customer avail of the discount while the balance of the receivables are collected on an avg. 75 days after the invoice date. Sunlight industries also has small dealer networks that shall the chemicals bad debt of the company are currently 1.5% of total sales. Sunlight industries finances its investment in debtors through a mix of bank credit and own long term funds in the ratio of 60:40 current cost of bank credit and long term funds are 12% and 15% respectively. There has been a consistent rise in the sales of company due to its proactive measures in cost reduction and maintaining good relations with dealers and customers. The projected sales for the next year are Rs 800 crore of 50% from last year. Gross profits have been maintain at a healthy 22% over the years and are expected to continue in futures. With escalating cost associated with the in-house management of debtors coupled with the need to unburden the management with the task so as to focus on sales promotion, the CEO of Sunlight Industry examine the possibility of outsourcing its factoring service for managing its receivables. He assigns the responsibility to Anita Guha, the CFO of Sunlight. Two Page | 30

FACTORING

proposals the details of which are given below are available for Anita’s consideration.

Proposal from Canbank Factors Ltd.

The main element of the proposal are : i.

Guaranteed payment within 30 days

ii.

Advance, 88% and 84% for the recourse and non-recourse arrangement respectively

iii.

Discount charge in advance 21% for recourse and 22% without recourse

iv.

Commission, 4.5% without recourse and 2.5% with recourse

Proposal from Indbank Factors Ltd.

The main element of the proposal are : i.

Guaranteed payment within 30 days

ii.

Advance 84% with recourse and 80% without recourse

iii.

Discount charge upfront, without recourse 21% and with recourse 20%

iv.

Commission upfront, without recourse 3.6% and with recorse 1.8%

The opinion of the chief Marketing manager is that in context of the factoring arrangement his staff would be able to exclusively focus on sales promotion which would result on additional sales of Rs 75 crore.

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FACTORING

Financial Analysis of Receivables Management Alternatives (Rs. in Crore) Particulars

Amount

(A) In house Management : Cash discount (Rs. 800 crore X 0.40 X 0.20)

6.4

Bad debts (Rs. 800 crore X 0.015)

12.0

Opportunity Cost (Forgone contribution on lost sales) (Rs. 75 crore X 0.205 net of bad debts)

15.4

Avoidable administrative and selling expenses

9.0

Cost of investment in receivables ©

14.4

Total Cost

57.2

© Avg. collection period = 49 days [(0.40 X 10 days) + (0.60 X 75days)] Investment in debtors: = Rs. 14.4 crore [(Rs. 108.9 crore X 0.60 X 0.12) + (Rs. 108.9 crore X 0.40 X 0.15)]

(Rs. in Crore) Particulars

Amount

Amount

(B) Canbank factors Proposal: With recourse Without recourse  Factoring Commission (Rs 875 crore X 0.025)

21.9

-

(Rs 875 crore X 0.045)

-

39.4

[Rs. 750.7* crore X 0.21 X (30/360)]

13.1

-

[Rs. 701.9** crore X 0.22 X (30/360)]

-

12.9

 Discount charge

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FACTORING

 Cost of long term funds in debtors: {[( Rs. 875 crore – Rs. 750.7 crore)] X [0.15 X (30/360)]} {[( Rs. 875 crore – Rs. 701.9 crore)] X

1.6 -

[0.15 X (30/360)]}

2.2

36.6

54.5

* Amount of Advance = Rs. 750.7crore [0.88 X (Rs. 875 cr. – Rs. 21.9 cr.)] ** Amount of Advance = Rs. 701.9crore [0.84 X (Rs. 875 cr. – Rs. 39.4 cr.)] (Rs. in Crore) Particulars

Amount

Amount

(C) Indbank Factor Proposal With recourse Without recourse  Factoring Commission (Rs 875 crore X 0.018)

15.7

-

(Rs 875 crore X 0.036)

-

31.5

[Rs. 721.8# crore X 0.20 X (30/360)]

12.0

-

[Rs. 674.8## crore X 0.21 X (30/360)]

-

11.8

1.9

-

 Discount charge

 Cost of long term funds in debtors: {[(Rs. 875 crore – Rs. 721.8 crore)] X [0.15 X (30/360)]} {[(Rs. 875 crore – Rs.674.8 crore)] X [0.15 X (30/360)]}

29.6

2.5

45.8 Page | 33

FACTORING #

Amount of Advance = Rs. 721.8 cr. [0.84 X (Rs. 875 cr. – Rs. 15.7 cr.)]

##

Amount of Advance = Rs. 674.8 cr. [0.80 X (Rs. 875cr. – Rs. 31.5 cr.)]

(Rs. in Crore) Decision Analysis: Recourse Factoring Particulars

Canbank

Indbank

45.2

45.2

 Costs

36.6

29.6

Net Benefits

8.6

15.6

 Benefits (Rs. 57.2 cr. – Rs. 12 cr.) (Bad debts to be borne by company)

Decision Analysis: Non-Recourse Factoring Particulars

Canbank

Indbank

58.3

58.3

 Costs

54.5

45.8

Net Benefits

3.8

12.5

 Benefits (Rs. 57.2 cr. + Rs. 1.1cr.) (Bad debts to be borne by factor)

Advice: My advice to the CFO of Sunlight Industries would be to accept the proposal of Indbank Factors for Recourse Factoring.

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FACTORING

CHAPTER 12 CONCLUSION

o Factoring is a money market instrument. o Since, factoring is not a negotiable instrument, customer’s consent is required about the factoring arrangement under which he will make a repayment directly to the factor but not to the client. o As a result of factoring services, the enterprise can concentrate on manufacturing and selling. o

The risk of bad debts is eliminated.

o

The factoring institution also provides advice on business trends and other related matters.

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FACTORING

BIBLIOGRAPHY BOOKS: o Financial Services In India - G. Ramesh Babu o Financial Services - By Khan o International Factoring in India: Issues, Problems & Prospects - A K Sengupta, V S Kaveri MAGAZINES: o Business Standard

NEWSPAPER: o Economic Times

WEBSITES: o www.canbankfactors.com

o www.sbiglobal.in o http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services o www.standardchartered.co.in o www.citibank.co.in

Page | 36