Lecture Retail and merchant banking – Lecture 14

After studying this chapter you will be able to understand: Financial services, factoring, features of factoring, mechanism of factoring, parties to the factoring, types of factoring, advance and maturity factoring, conventional or full factoring, domestic and export factoring.

Revise Lecture 14

Financial Services

Factoring

Financial services

Factoring:

* Asmall firm may handle the problem of

receivables management of Its own, but It may not be possible for a large firm to do

SO efficiently as it may be exposed to the risk of more and more bad debts

- In such a case, a firm may avail the

services of specialied institution engaged

In receivables management, called

factoring firms.

Financial services

Factoring:

1 Finance for the supplier including loans

and advance payments

2 Maintenance of accounts, ledgers relating

to receivables

3 Collection of debts

4 Protection against credit risks In

payments by debtors

‘ Features of Factoring

Financial services

Features of Factoring:

1 Factoring Is a service of financial nature

Involving the conversion of credit bills into cash Accounts receivables, bills

recoverables and other credit dues

resulting from credit sales appear in the books of account as book credits

» The risks associated with credit are taken

over by the factor which purchases these

credit receivables without recourse and

Financial services

Features of Factoring:

4 Factor acts as another financial

Intermediary between the buyer and the

seller

5 Unlike a bank, a factor specializes in handling and collecting receivables in an efficient manner The factor receives the payments directly since the Invoices are assigned in favour of It

Mechanism of Factoring

Financial services

Mechanism of Factoring:

- The mechanism of factoring is Summed up

as the following;

An agreement Is entered into between

the selling firm and the buying firm

2 The sales documents should contain the

Instructions to make payments directly to the factor who Is assigned the job of

collection of receivables.

Financial services

Mechanism of Factoring:

3 When the payment is received by the

factor, the account of the firm is credited by the factor deducting Its fee, charges, Interest etc as agreed upon

4 The factor may provide advance finance

to the selling firm if the conditions of the

agreement so require

‘ Parties to the Factoring

Financial services

Parties to the Factoring

- There are basically three parties involved

In a factoring transactions:

The buyer of the goods

2 The seller of the goods

3, The factor, |.e the financial institution

- The three parties interact with each other during the purchase / sale of goods

Lecture 15

‘ Types of Factoring

Financial services

Types of Factoring:

* Anumber of factoring arrangements are

possible depending upon the agreement reached between the selling firm and the factor

- The most common feature of practically all the factoring transactions Is collection of receivables and administration of sale

ledger

Financial services

Types of Factoring:

1 However, the following are some of the

important types of factoring

arrangements;

Recourse and non-recourse factoring Advance and maturity factoring

Conventional or full factoring

Domestic and export factoring

Financial services

Types of Factoring:

Selected seller based factoring

8 Selected buyer based factoring

9 Disclosed and undisclosed factoring

Financial services

Types of Factoring: Recourse & Non-

recourse

* In a recourse factoring arrangement, the

factor has recourse to the client (selling

firm) if the receivables purchased turn out

to be bad

‘ Let the risk of bad debt Is to be borne by

the client and the factor does not assume credit risks associated with the

receivables.

by the factor and he cannot claim this

amount from the selling firm

- Since here he bears the risk of non-

payment, commission or fee charged for

the services is higher than that under the

Financial services

Types of Factoring:

- Advance and maturity factoring

Financial services

Advance and maturity factoring

- Under advance and maturity factoring

arrangement, the factor pays only a

certain percentage (between 70% and

90%) of the receivables in advance to the client, the balance being paid on the

guaranteed payment date

- The rate of discount / interest Is

determined on the basis of the

creditworthiness of the client and volume

- Conventional or full factoring

Financial services

Conventional or full factoring

- Under this system, the factor performs

almost all services of collection of

receivables, maintenance of sales ledger,

credit collection, credit control and credit Insurance

‘ In advanced countries, all these methods are popular, but in Pakistan, it is only In the beginning stage

- Domestic and export factoring

Financial services

Domestic and export factoring

- The basic difference between the

domestic and export factoring Is on

account of the number of parties involved

- In the domestic three parties are involved;

1 Customer (buyer)

2, Client (seller)

3 Factor (financial intermediary)

- Export factoring is also termed as cross

border / international factoring and Is

almost similar to domestic factoring except that there are four parties to the factoring transaction;

The exporter (the selling firm or client)

The importer or the customer

The export factor

Financial services

Domestic and export factoring

- Since, two factors are involved in the

export factoring, it is also called two-factor system

‘ Limited factoring

Financial services

Limited factoring

- Under this, the factor discounts only

certain invoices on selective basis and

converts credit bills into cash in respect of those selected bills only

- Selected seller based

factoring

Financial services

Selected seller based factoring

The seller sells all his accounts

receivables to the factor along with Invoice delivery challans, contracts etc after

Invoicing the customers

- The factor performs all functions of

maintaining the accounts, collecting the

debts, sending reminders to the buyers

- The sellers are normally approved by the

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- Selected buyer based factoring

Financial services

Selected buyer based factoring

- The factor first of all selects the buyers on the basis of their goodwill and

creditworthiness and prepares an

approved list of them

- The approved buyers of a company

approach the factor for discounting their purchases of bills receivables drawn In

favour of the company

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- Disclosed and undisclosed

factoring

Financial services

Disclosed and undisclosed factoring

- In disclosed factoring, the name of the

factor is mentioned in the invoice by the

Supplier telling the buyer to make payment

to the factor on the due date

- However, the supplier may continue to

bear the risk of bad debts without passing

it to the factor

‘ The factor assumes the risk only under

Financial services

Disclosed and undisclosed factoring

- Under undisclosed factoring, the name of

the factor is not disclosed in the invoice But still the control lles with the factor

- He maintains sales ledger of the seller of goods and provides short-term finance

against the sales invoices, but the entire transactions take place in the name of the Supplier company (seller)

- Functions of a Factor

Financial services

Functions of a Factor

- The purchase of a book debts or

receivables Is central to the functions of factoring permitting the factor to provide the basic services such as;

1 Administration of seller’s sales ledger

2 Collection of receivables purchased

3, Provision of finance

Protection aqaainst risk of bad debts /