Meaning of Factoring: Commerce YouTube Lecture Handouts
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Topics to be covered are
- Meaning of Factoring
- Features Of Factoring
- Functions of factor
- Types Of Factoring
- Factoring Procedure
- Common Factoring Term
- Advantages of Factoring
- Disadvantages of Factoring
Meaning of Factoring
- 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.
Features of Factoring
- Credit cover
- Cash advances
- Sales ledgering
- Collection service
- Provide valuable advice
Functions of Factor
- Maintenance of Sales Ledger
- Financing
- Credit control and credit Protection
- Collection of Money
- Advisory Functions
Types of Factoring
- Recourse and Non-recourse Factoring
- Disclosed and Undisclosed Factoring
- Domestic and Export Factoring
- Advance and Maturity Factoring
Factoring Procedure
- The seller sells the goods to the buyer and raises the invoice on the customer.
- The seller then submits the invoice to the factor for funding. The factor verifies the invoice.
- After verification, the factor pays 75 to 80 percent to the client/seller.
- The factor then waits for the customer to make the payment to him.
- On receiving the payment from the customer, the factor pays the remaining amount to the client.
- Fees charged by factor or interest charged by a factor may be upfront i.e.. in advance or it may be in arrears. It depends upon the type of factoring agreement.
- In case of non – recourse factoring services factor bears the risk of bad debt so in that case factoring commission rate would be comparatively higher.
Common Factoring Term
- Discount rate or factoring fee
- Advance rate
- Reserve account
- Spot factoring
Advantages of Factoring
- Factoring is a way to finance requirement of working capital of the company in respect of receivables.
- Factoring provides a large and quick increase in cash flow of the business.
- Prices are usually competitive due to existence of many factoring companies.
- Companies might get useful information about the creditworthiness of its customers as factoring firms are specialised in their field.
- If non – recourse factoring is chosen, there is protection from bad debts.
- Factoring does not require to risk home or other property as collateral like traditional bank loans.
- Factoring firms give a cash advance on upto 80% of receivables, that is more than one would be able to get from a bank.
- The enterprise can concentrate on manufacturing and selling as a result of factoring services.
- The factoring institution also provides advice on business trends and other related matters.
- In India, subsidiaries of four Indian banks- State Bank of India, Canara Bank, Punjab National Bank and Allahabad Bank are providing factoring services.
Disadvantages of Factoring
- Selling company gets locked with the factor as they rely completely on the services of a factor.
- Harms Company՚s relationship with their customers.
- Factoring was considered a sign on the financial difficulties of the company.
- In the case of non – recourse factoring the factoring company pre approve the selling company՚s customers, which cause delay in placing new orders.
- The selling company may have to pay extra to remove its liability for bad debts.
- Some customers might want to deal directly with the selling company instead of dealing with factor.
- The factor may want to set credit limits for customers, which may affect the way trade is done.
✍ Manishika