Factoring is a big help for traders.
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The main purpose of factoring is to provide financial liquidity to a company whose capital is locked in its invoices awaiting realization of the payments from its clients to whom it has rendered some service or provide some supplies.
So, what they do is sell the debts that are pending in their books.
Parties involved in factoring
Irrespective of the number of debtors who have to pay, the transactions are triangular:
1. The Supplier / Trader / Manufacturer who provides goods or services to the debtor,
2. The debtor who has availed the supply / services to the Supplier / Trader / Manufacturer, and
3. The Factor which is a bank or a financial institution which takes on the liability for a fee; this is normally a small agreed percentage of the total debt. He may also be a party to any disputes that my result or arise in the transactions.
In effect, the Factor is a financially sound intermediary:
1. Who assesses the risk factors involved,
2. Buys out the Invoices of a Manufacturer / Supplier / Trader,
3. Pays the client in advance so that he can keep his business moving, and
4. Agrees to collect the payments from the debtor.
Logistics of factoring
• The client (seller or service provider) assigns the invoice to the Factor and informs the customers from whom the invoiced payments are due,
• The delivery documents and a copy of the invoices / delivery challans are given to the Factor,
• After scrutiny, the factor pays the advance to the client (about 80%),
• The balance is called Factor Reserve,
• Balance payments after deducting Factor fees are sent to the Client on realization of the dues.
TYPES OF FACTORING
o Factoring is upto 85% of receivables,
o Credit Risk is with the Client.
o Credit sanction does not involve factor.
o Factor absolves client of responsibility for non-recovery,
o Credit risk is with the Factor.
o Factoring charges are higher,
o Factor is involved in credit sanction and approval of credit limit to the Customer.
o In USA/UK, without recourse Factoring is very popular.
o No advance payment to the Client,
o Pays on collection of amounts or on a pre-set date,
o Guaranteed date set as per past history,
o Commision is quite low since no risk is taken.
CROSS – BORDER FACTORING
o Exporter and importer have their own Factors and agreements,
o Both Factors set up the mechanism for evaluation and the fees for collection,
o Remarks about payments by importer are affixed on the invoice,
o Import Factor collects payment, deducts his fees, and pays the balance to the Export Factor,
o Export Factor deducts his fees and passes on the balance to the Exporter,
o Currency exchange rates are paid as per the agreements.
1. Each bill discounted individually,
2. Financier does not maintain ledger or carry out collections,
3. Customers of the client not informed,
4. Only done with recourse, and
5. Re-discounting is permitted.
1. Pre-payment is made only against unpaid invoices purchased by Factor,
2. Factor maintains Sales Ledger and collects debts,
3. The client’s customers are informed of the Notice of assignment ,
4. Factoring may be done without or without recourse to client,
5. Re-discounting by factor is prohibited.
Why Factoring fails
o Reluctant policy of Banks towards providing factoring services,
o Bank’s hesitation in issuing Letter of Disclaimer (which is mandatory as per Guidelines).
o Problems faced in recovery,
o Stamp Duty becomes necessary while assigning debts,
Consequently, the cost of transactions becomes higher and untenable.
Other reasons for failure of Factoring
• While factoring companies are very professional in taking up an account, wrong or misleading financial details given to the factor may lead to rejection or complications later.
• Concealing financial information regarding debts, liens, litigations or omitting other details can also be the reason for failure,
• Insufficient Documentation,
• Offering invoices for factoring though supply or service is not yet delivered,
• Concealment of hidden costs by the factor, and
• A client receiving payment from the customer without informing factor; this is an illegal action that may invite litigation.
Not Reviewing Monthly Minimums
Some invoice factoring agreements require a minimum volume of invoices each month. This can means incurring minimum fees and higher costs than the advertised rate if you don’t hit the minimum requirements. To be in control of your financing costs, make sure you work with a company that doesn’t require monthly minimums.
Overlooking Hidden Fees
Many factoring companies offer low teaser rates, increasing their profits by imposing application fees, credit check fees, ACH fees, monthly service fees, long-term contracts and monthly minimum fees. Descriptions of these fees are mostly concealed in small print, making them easy to miss during the application process.
Don’t fall for teaser rates or a bait and switch sales tactic. Work with a factoring company that gives you clear and simple terms.
Factoring Invoices for Undelivered Services
To ensure payment, factoring companies only purchase invoices for products or services that have been completed and/or delivered services. The company verifies each invoice before releasing funds, and you cannot receive an advance on work that has yet to be completed or delivered. You must make sure you only submit invoices for work that is truly complete. Sometimes, companies think they can factor long-term contracts. A contract is not an invoice, it is a commitment for future work. For recurring or subscription billing, you cannot factor a purchase order for work that is billed a month in advance, unless it is a retainer that will be paid regardless of whether work is done or not. You could however, factor an invoice for work that was completed in the previous month.
Misdirecting payment means getting paid directly on an invoice for which factoring has already been done. This is a form of fraud. The factor has purchased the invoice, so by misdirecting the payment, you derive a second payment for the same invoice.
This will not only hurt your relationship with your factoring company, it might trigger penalties, and lead the factoring company to terminate the relationship.
Comparison of various funding techniques
Subject Bills Discounting Factoring Forfaiting
Extent Upto 80% Upto 80% Upto 100%
Recourse Yes Optional Without recourse
Scrutinizing documents Individually Service of sale Individual
Sales administration Not done Done Not done
Term Short Short Longer
Creating charge Hypothecation Assigning Assigning
In doing business, the best of enterprises have to resort to various strategies since the financial inflows and the payments may not be matching consistently. Factoring is one of the means to remain afloat in the absence of prompt, timely payments from customers who have availed a service or supply.
The owner of the enterprise needs to make the following assessment:
1. The amounts of outstanding unpaid invoices,
2. The amount of payments and the approximate rate of inflows that are expected realistically,
3. Keeping that in mind, how much of the outstanding invoices do you need funded to survive the cash crunch?
4. The type of Factoring support required and how much do you wish to pay for it.
Benefits of Factoring Invoices
It thus eases its cash crunch by approaching a financial institution that buys out its debts and provides the much needed cash to the manufacturer/supplier/trader whose company is suffering a resource crunch due to unrealized book debts.
The terms agreed between the client and the factor may be that:
a. Payment to the client will be made on a guaranteed date every month or on agreed dates; or
b. Only when they are collected, the client releases the payment.
Hence, as soon as the factor purchases the book debts, he pays an agreed amount to the client. The factor also collects an agreed fee for this purpose later on. Thus, the client is able to pump the cash received (mostly in the region of 80% of the book debt) into his business.
The client avoids locking up of his money and the factor earns an amount as fee for this service.
The main purpose of factoring invoices is:
• Growth of funds,
• Generating working capital to pay daily bills, and
• Negotiating discounts.
As against the stricter norms of banks, Factoring companies are more lenient; part of the reason may be that they are better equipped to provide immediate cash as also to enforce stricter collections.
They collect the dues and pay you after taking their agreed cut.
The unique distinction between taking a loan from a financial institution and factoring is that your credit worthiness is not a consideration; on the contrary, it is the credit worthiness of your customers who have to pay the amounts towards the invoices.
It’s not a Debt yet improves Cash flow
Since it is only an advance payment, it does not reflect on the balance sheet.
Fast Access to Cash
Though the application and agreement may take up to one week, the actual disbursement of cash will be much faster. Funding of approved invoices takes place within 24 hours generally. No bank can be so efficient.
Reasonable Factoring fees
Competition and competence of Factors has resulted in fees plummeting to 1.5% of the invoiced value; agreed factoring may be as high as 95% in better cases.
Factoring offers you flexible terms that provide you ease of compliance; you choose what invoices you want to put up for factoring and when. Factoring gets better as your company grows,
Stay in control and tension free
While factoring takes care of your needs, the Factor does not dictate to you; so, it is a win-win situation for you.
Extending Terms to clients confidently
It empowers you with a confidence to increase sales without depleting your cash flow. Providing terms to large customers and new customers becomes easy. You can also confidently stop providing terms risky companies.
Factoring also reduces your workload and consequently your establishment costs. Moreover, Factoring companies are highly professional and they maintain their ledgers etc very professionally.
In conclusion, we may say that the very act of collections by some other agency takes a big load off your head.
Factoring in the USA
While the basics of factoring remain the same, it is essential that the client pays minute attention to details; the same applies to the factor too.
As at present, the following are the main sectors are enjoying the benefits of Invoice factoring in the USA:
• Auto Industry,
• Agricultural sector,
• Cable Industry,
• Construction and real estate,
• Transportation and warehousing,
• Government sector,
• Maintenance and facility management,
• Distribution and manufacturing,
• Oil and natural gas,
• Security and Concierge services, and
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Written for: Lars-Magnus Carlsson.
Tuesday, October 03, 2017