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Lecture Retail and merchant banking – Lecture 14

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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.

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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

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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

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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

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Financial services

Features of Factoring:

4 Factor acts as another financial

Intermediary between the buyer and the

seller

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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

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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

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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

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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

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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

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Financial services

Types of Factoring:

Selected seller based factoring 8 Selected buyer based factoring

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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

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Financial services

Types of Factoring: Recourse & Non- recourse

- In the case of non-recourse factoring, the risk or loss on account of non-payment by the customers of the client Is to be borne

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

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Financial services

Types of Factoring:

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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

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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

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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)

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Financial services Domestic and export factoring 1 2 3

- 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

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Financial services

Domestic and export factoring

- Since, two factors are involved in the

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Financial services

Limited factoring

- Under this, the factor discounts only

certain invoices on selective basis and

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- Selected seller based

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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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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

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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

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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

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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 /

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