Define Factoring and Forfeiting Services

Introduction

Factor is derived from the Latin word ‘facere’ which means ‘to get things done’. Factoring is an arrangement between an agency (the factor) and a business concern. This arrangement is a financial service which is provided by an institution called factor. The factor undertakes the task of realizing debts, bills receivables on behalf of its customer and makes payment to its client’s creditors. For this service the factor receives commission. The entire process is known as ‘factoring’. Factoring services originated in USA, and UK. The specialized financial institutions were established to do this financial service. It helps firms to meet their working capital requirements by selling their receivables.

Definition of Factoring

According to Peter M. Biscose factoring is “a continuing legal relationship between a financial institution (the factor) and a business concern (the client) selling goods or providing services to trade customers, whereby the factor purchases the clients’ book debts, either with or without recourse to the client, and in relation thereto, controls the credit extended to customers, and administers the sales ledger”.

According to the report submitted to the RBI by Mr. C.S. kalyanasundaram, factoring as, “a continuing arrangement under which a financing institution assumes the credit and collection functions for its client, purchases receivables as they arise (with or without recourse for credit losses, i.e., the customer’s financial inability to pay), maintains the sales ledger, attends to other book-keeping duties relating to such accounts and performs other auxiliary functions.”

Thus, factoring is an agreement or arrangement between two parties (a firm and a factor), in which to collect or purchase the book debts of the firm by the factor, for a commission or profit.

Characteristics of Factoring

Factoring is an arrangement between financial institution and a business concern

It is an activity of selling the firm’s receivables to a factoring organization.

Book debts are assigned in favour of a factor.

Factoring is not a negotiable instrument

Factor acts as a collection agent or representative of a firm

Factor charges commission or gets discount on the book debts

Factor can get margin in the range of 5 percent to 20 per cent.

The normal period of factoring is 90-150 days and rarely exceeds 150 days.

Factoring is not possible in case of bad debts.

Credit rating is not mandatory.

Factoring can be with or without recourse to the seller on non-payment by the buyers.

It is a method of ‘off balance sheet’ financing.

Cost of factoring is always equal to finance cost plus operating cost.

Modus Operandi of factoring

There are three parties to a domestic factoring arrangement. It includes a business Firm who is supplier or seller of goods and services, Debtor who is a buyer of goods and services provided by the firm, and a Factor who is a financial institution or intermediary between Firm and Debtor who provides the factoring services.

Generally, the firm sells the goods to the buyer or customer on credit. He sends invoices to the customer directly and also collects payment directly from the customer. The firm may also arrange factor to collect the receivables. Various processes are involved when the firm entrust the collection activities to the factor.

Let us now study the Modus operandi of factoring with the help of a picture as follows:

Firm gets an order of purchase of goods/services on credit through its customer

Firm sends goods/services and invoice to his customer (debtor) and the firm may inform or direct that the invoice is assigned to and must be paid to a factor.

Firm sends invoice to the factor, along with other valid proof of dispatch

Factor provides pre-payment to the client, it can be up to 80-90 per cent of the invoice value

Factor follows up with the customers for realisation of payment due

Debtor pays money to the factor on due date (i.e., factor collects book debts)

Factor makes the balance payment of the invoice value to the client

Through the invoices presented, the factor maintains the sales ledger for the client and statements of accounts are sent to the customer on a monthly basis. The factor takes over the collection of book debts, and reminders are sent when the invoices are overdue. The client gets information about all the factoring transactions through monthly and weekly reports provided by the factor.