Factoring 

is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a

third party (called a factor) at a discount in exchange for immediate money with which to finance
continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the
value of thereceivables (essentially a financial asset)[1], not the firm’s credit worthiness. Secondly,
factoring is not aloan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves
two parties whereas factoring involves three.

It is different from the forfaiting in the sense that forfaiting is a transaction based operation while factoring
is a firm-based operation - meaning, in factoring, a firm sells all its receivables while in forfaiting, the firm
sells one of its transactions.

Factoring is a word often misused synonymously with invoice discounting[citation needed] - factoring is the sale
of receivables whereas invoice discounting is borrowing where the receivable is used as collateral.

The three parties directly involved are: the one who sells the receivable, the debtor, and the factor.
Thereceivable is essentially a financial asset associated with the debtor’s liability to pay money owed to
the seller (usually for work performed or goods sold). The seller then sells one or more of its invoices
(thereceivables) at a discount to the third party, the specialized financial organization (aka the factor), to
obtain cash. The sale of the receivables essentially transfers ownership of the receivables to the factor,
indicating the factor obtains all of the rights and risks associated with the receivables.[2] Accordingly, the
factor obtains the right to receive the payments made by the debtor for the invoice amount and must bear
the loss if the debtor does not pay the invoice amount. Usually, the account debtor is notified of the sale
of the receivable, and the factor bills the debtor and makes all collections. Critical to the factoring
transaction, the seller should never collect the payments made by the account debtor, otherwise the seller
could potentially risk further advances from the factor. There are three principal parts to the factoring
transaction; a.) the advance, a percentage of the invoice face value that is paid to the seller upon
submission, b.) the reserve, the remainder of the total invoice amount held until the payment by the
account debtor is made and c.) the fee, the cost associated with the transaction which is deducted from
the reserve prior to it being paid back the seller. Sometimes the factor charges the seller a service
charge, as well as interest based on how long the factor must wait to receive payments from the
debtor. [3] The factor also estimates the amount that may not be collected due to non-payment, and makes
accommodation for this when determining the amount that will be given to the seller. The factor's overall
profit is the difference between the price it paid for the invoice and the money received from the debtor,
less the amount lost due to non-payment.[2]
 Factoring in India
What is factoring?

Factoring is a financial option for the management of receivables. In simple definition

it is the conversion of credit sales into cash. In factoring, a financial institution (factor)
buys the accounts receivable of a company (Client) and pays up to 80%(rarely up to
90%) of the amount immediately on agreement. Factoring company pays the
remaining amount (Balance 20%-finance cost-operating cost) to the client when the
customer pays the debt. Collection of debt from the customer is done either by the
factor or the client depending upon the type of factoring. We will see different types
of factoring in this article. The account receivable in factoring can either be for a
product or service. Examples are factoring against goods purchased, factoring for
construction services (usually for government contracts where the government body is
capable of paying back the debt in the stipulated period of factoring. Contractors
submit  invoices to get cash instantly), factoring against medical insurance etc. Let us
see how factoring is done against an invoice of goods purchased.

Characteristics of factoring
 1. Usually the period for factoring is 90 to 150 days. Some factoring companies
allow even more than 150 days.

2. Factoring is considered to be a costly source of finance compared to other

sources of short term borrowings.

3. Factoring receivables is an ideal financial solution for new and emerging firms
without strong financials. This is because credit worthiness is evaluated based
on the financial strength of the customer (debtor). Hence these companies can
leverage on the financial strength of their customers.

4. Bad debts will not be considered for factoring.

5. Credit rating is not mandatory. But the factoring companies usually carry out
credit risk analysis before entering into the agreement.

6. Factoring is a method of off balance sheet financing.

7. Cost of factoring=finance cost + operating cost. Factoring cost vary according

to the transaction size, financial strength of the customer etc. The cost of
factoring vary from 1.5% to 3% per month depending upon the financial
strength of the client's customer.

8. Indian firms offer factoring for invoices as low as 1000Rs

9. For delayed payments beyond the approved credit period, penal charge of
around 1-2% per month over and above the normal cost is charged (it varies
like 1% for the first month and 2% afterwards).

Different types of Factoring

1. Disclosed and Undisclosed

2. Recourse and Non recourse

A single factoring company may not offer all these services.

Disclosed

In disclosed factoring client's customers are notified of the factoring agreement.

Disclosed type can either be recourse or non recourse.

Undisclosed
In undisclosed factoring, client's customers are not notified of the factoring
arrangement. Sales ledger administration and collection of debts are undertaken by the
client himself. Client has to pay the amount to the factor irrespective of whether
customer has paid or not. But in disclosed type factor may or may not be responsible
for the collection of debts depending on  whether it is recourse or non recourse.

Recourse factoring

In recourse factoring, client undertakes to collect the debts from the customer. If the
customer don't pay the amount on maturity, factor will recover the amount from the
client. This is the most common type of factoring. Recourse factoring is offered at a
lower interest rate since the risk by the factor is low. Balance amount is paid to client
when the customer pays the factor.

Non recourse factoring

In non recourse factoring, factor undertakes to collect the debts from the customer.
Balance amount is paid to client at the end of the credit period or when the customer
pays the factor whichever comes first. The advantage of non recourse factoring is that
continuous factoring will eliminate the need for credit and collection departments in
the organization.

Factoring companies in India

Canbank Factors Limited: http://www.canbankfactors.com

SBI Factors and Commercial Services Pvt. Ltd: http://www.sbifactors.com

The Hongkong and Shanghai Banking Corporation

Ltd: http://www.hsbc.co.in/1/2/corporate/trade-and-factoring-services

Foremost Factors Limited: http://www.foremostfactors.net

Global Trade Finance Limited: http://www.gtfindia.com

Export Credit Guarantee Corporation of India

Ltd: https://www.ecgc.in/Portal/productnservices/maturity/mfactoring.asp

Citibank NA, India: http://www.citibank.co.in

Small Industries Development Bank of India (SIDBI): http://www.sidbi.in/fac.asp

Standard Chartered Bank: www.standardchartered.co.in

Factoring
Definition: A financing method in which a business owner sells accounts receivable at a discount to
a third-party funding source to raise capital
One of the oldest forms of business financing, factoring is the cash-management tool of choice for
many companies. Factoring is very common in certain industries, such as the clothing industry,
where long receivables are part of the business cycle.
In a typical factoring arrangement, the client (you) makes a sale, delivers the product or service and
generates an invoice. The factor (the funding source) buys the right to collect on that invoice by
agreeing to pay you the invoice's face value less a discount--typically 2 to 6 percent. The factor pays
75 percent to 80 percent of the face value immediately and forwards the remainder (less the
discount) when your customer pays.

Because factors extend credit not to their clients but to their clients' customers, they are more
concerned about the customers' ability to pay than the client's financial status. That means a
company with creditworthy customers may be able to factor even if it can't qualify for a loan.
Once used mostly by large corporations, factoring is becoming more widespread. Still, plenty of
misperceptions about factoring remain.

Factoring is not a loan; it does not create a liability on the balance sheet or encumber assets. It is
the sale of an asset--in this case, the invoice. And while factoring is considered one of the most
expensive forms of financing, that's not always true. Yes, when you compare the discount rate
factors charge against the interest rate banks charge, factoring costs more. But if you can't qualify
for a loan, it doesn't matter what the interest rate is. Factors also provide services banks do not:
They typically take over a significant portion of the accounting work for their clients, help
with credit checks, and generate financial reports to let you know where you stand.
The idea that factoring is a last-ditch effort by companies about to go under is another
misperception. Walt Plant, regional manager with Altres Financial, a national factoring firm based in
Salt Lake City, says the opposite is true: "Most of the businesses we deal with are very much in an
upward cycle, going through extremely rapid growth." Plant says you may be a candidate for
factoring if your company regularly generates commercial invoices and you could benefit from
reducing the time receivables are outstanding. Factoring may provide the cash you need to fund
growth or to take advantage of early-payment discounts suppliers offer.
Factoring is a short-term solution; most companies factor for two years or less. Plant says the
factor's role is to help clients make the transition to traditional financing. Factors are listed in the
telephone directory and often advertise in industry trade publications. Your banker may be able to
refer you to a factor. Shop around for someone who understands your industry, can customize a
service package for you, and has the financial resources you need.