Factoring and Forfaiting

COMMERCIAL BANKING
TERM PROJECT
Presented By:
Rajan A - B12035
Lakshman Singh - B12021
Sunil Manchandia - B12051
2013
Praxis Business School A Brand
Dossier - Sundrop Oil
FACTORING AND FORFAITING

Agenda
2
 Factoring
 Steps in Factoring
 Factoring Process
 Types of Factoring
 Pros and Cons of Factoring
 Factoring Vs. Bank Loan
 Factoring Vs. Bills Discounting
 Eligibility and Documentation
 Factor’s Fees and Expenses
 Forfaiting
 Forfaiting Process
 Costs Involved in Forfaiting
 Factoring Vs. Forfaiting
 Comparative Analysis – Bills Discounting, Factoring and Forfaiting
Praxis Business School Factoring and Forfaiting

Factoring
3
 Factoring can be defined as the conversion of credit sales into
cash.
 Factoring is a transaction where the exporter sells its receivables
to a financial institution which is usually a bank.
 The Factoring institution buys the accounts receivable and pays
up to 80% of the amount to a company usually a client.
 Examples includes factoring against goods purchased, factoring
against medical insurance, factoring for construction services etc.

Parties Involved In Factoring
4
 So, a Factor is,
 A Financial Intermediary
 That buys invoices of a manufacturer or a trader, at a discount,
and
 Takes responsibility for collection of payments.
 The factoring transaction involves three parties:
 Supplier or Seller (Client)
 Buyer or Debtor (Customer)
 Financial Intermediary (Factor)

Steps in Factoring
5
Customer places the order with client
Client obtains a prepayment limit from factors
Client delivers goods/services to the customers
Copies of invoices, along with a notice to pay submitted to factors
Factors makes a prepayment advance to the client
Factors follows up on payment with the customers
Customer makes payments for factors
Factors makes the balance payment to the client
Step 1
Step 2
Step 3
Step 4
Step 5
Step 6
Step 7
Step 8

Factoring Process
6

International Factoring Process
7
Source: HSBC

Types of Factoring
8
Types of Factoring
Disclosed
Recourse
Non-
Recourse
Maturity Advance
Undisclosed

Pros and Cons of Factoring
9
Pros
 Receive cash as soon as orders
are invoiced
 Improves cash cycle
 Protection from bad debts (if
you choose non-recourse
factoring)
 Inexpensive way to collect
debts
Cons
 It can be expensive
 Hamper relationship with
customers
 Exiting the agreement can be
difficult

Factoring Vs. Loan
10
 Factoring is a word often misused synonymously with bank loan.
 Factoring is a financial transaction whereby a business sells its accounts
receivable (i.e., invoices).
 Factoring differs from a bank loan in three main ways.
 The emphasis is on the value of the receivables, not the firm’s credit
worthiness.
 Factoring is not a loan – it is the purchase of an asset (the receivable).
 A bank loan involves two parties whereas factoring involves three

Factoring Vs. Bills Discounting
11
Factoring
 Responsibility of collection of
Debts
 Can be done with or without
recourse
 Pre-payment made against all
unpaid and not due invoices
purchased by Factor
 Notice of assignment is
provided to customers of the
Client
 credit/ payment risk on factor
Bills Discounting
 No responsibility of collection
of Debts
 Usually done with recourse
 Bill is separately examined and
discounted
 No notice of assignment
provided to customers of the
Client
 Credit risk on client

Eligibility and Documentation
12
 Factoring Solutions are offered to the following type of concerns
 Sole Proprietorships
 Partnerships
 Private Limited Companies
 Other criteria
 The entity should be in operation for the last 3 years
 The entity should have generated profits during the last 2 years and should satisfy
our internal credit parameters.
 The concern must have a positive tangible net worth.
 Proof of identity
 Proof of individual identity
 Proof of residence address
Source: HSBC India

Factor’s Fees and Expenses
13
 Commissions: Factors charge commissions for the credit risk they assume and
for providing bookkeeping, ledgering, collection and other administrative
services to their clients (0.50% to 1.50%)
 Commitment fees: Factors typically charge commitment fees at inception of
the factoring facility
 Interest: Factors charge interest on prepayment
 Additional fees: Additional fees may apply in any given factoring agreement.
For example, some factors charge minimum monthly discount fees, and early
termination fees may also apply if the client wants to terminate the
arrangement ahead of its stated expiration date

Factoring Companies in India
14
 Canbank Factors Limited
 SBI factors and commercial services Pvt. Ltd
 HSBC
 Foremost Factors Limited
 Global Trade Finance Limited
 Citibank India
 Small Industries Development Bank of India (SIDBI)
 Standard Chartered Bank

Why Factoring Has not become popular in India
15
 Banks’ reluctance to provide factoring services
 Bank’s resistance to issue Letter of Disclaimer (Letter of Disclaimer is
mandatory as per RBI Guidelines).
 Problems in recovery.
 Factoring requires assignment of debt which attracts Stamp Duty.
 Cost of transaction becomes high

Forfaiting
16
 The terms forfaiting is originated from a old French word ‘forfait’, which
means forfeiting or surrender of right.
 Forefaiting is a mechanism by which the right for export receivables of an
exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without
recourse to him.
 Forfaiting is a mechanism of financing export
 Available by discounting export receivable
 Evidenced by bills of exchange or promissory notes
 Without recourse to the seller (viz. exporter)
 Operated on a fixed rate basis (discount)
 Available upto 100% of the contract value.

Forfaiting Process
17

Pros and Cons of Forfaiting
18
Pros
 100 per cent financing
 Improves cash flow
 Reduced administration cost
 Increased trade opportunity
 Eliminates the risk of non-
payment
 Risk elimination (Exchange risk,
and political risks etc)
Cons
 It is very expensive (banks take
high fees due to high risks)
 Not available for short period
 Not available in financially
week country

Costs Involved in Forfaiting
19
 Commitment Fee:- Payable to Forfaiter by Exporter in consideration of
forfaiting services.
 Commission:- Ranges from 0.5% to 1.5% per annum.
 Discount Fee:- Discount rate based on LIBOR for the period concerned.
 Documentation Fee:- where elaborate legal formalities are involved.
 Service Charges:- payable to Bank.

Factoring Vs. Forfaiting
20
Points of Difference Factoring Forfaiting
Extent of Finance
Usually 75 – 80% of the value of the
invoice
100% of Invoice value
Finance
Short-term finance (90 to 150 days or
more)
Long Term Finance (180 days to 7
years)
Credit Worthiness
Factor does the credit rating in case of
non-recourse factoring transaction
The Forfaiting Bank relies on the
creditability of the Avalling Bank.
Services provided
Day-to-day administration of sales and
other allied services
No services are provided
Recourse With or without recourse Always without recourse
Sales By Turnover By Bills

Comparative Analysis
21
Bills Discounted Factoring Forfaiting
Scrutiny
Individual Sale
Transaction
Service of Sale
Transaction
Individual Sale
Transaction
Extent of Finance Upto 75 – 80% Upto 80% Upto 100%
Recourse With Recourse
With or Without
Recourse
Without Recourse
Sales
Administration
Not Done Done Not Done
Term Short Term Short Term Medium Term
Charge Creation Hypothecation Assignment Assignment

22
THANK YOU

Factoring and Forfaiting

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