UNIT III

FACTORING BILL DISCOUNTING

FACTORING

TOPICS
CONCEPT

PROCESS
FORMS FUNCTIONS

LEGAL

ASPECTS FINANCIAL EVALUATION COST OF FACTORING DECISION ANALYSIS FACTORING SCENARIO IN INDIA

INTRODUCTION
Two

types of problems:

problem of raising funds to finance, problems relating to collection, delays and defaults of the receivables Proper control and mgt of receivables factoring firms
RBI Committee headed by Shri C S Kalyan Sundaram basis- SBI(1991)Subsidiary(SBI Factors Ltd) capital of Rs 25 crores western zone.

MEANING
form latin word Facere to make or to do. To get things done FACTOR: is an agent, as a banking or insurance company, engaged in financing the operations of certain companies or in financing wholesale or retail trade sales, through the purchase of account
Derived

receivables.

FACTORING
It

is method of financing whereby a company sells its trade debts at a discount to a financial institution.
COMPANY SELLS seller CUSTOMERS WHO HAVE TO PAY Debtor/buyer

FACTOR

FIs, banks, insurance cos

 Arrangement

between a factor and his client which includes atleast two of the following services: Finance Maintenance of accounts Collection of debts Protection against credit risks

DEFINITION according to International Institute for the Unification of Pvt. Law-(UNIDROIT)

ACCORDING TO V A AVADHANI
Factoring is a service of financial nature involving the conversion of credit bills into cash

FACTORING
SELLER BUYER

80% OF INVOICE & 20% LATER

Invoice
FACTOR

NATURE OF FACTORING
Fund

based service/asset based Conversion of credit bills into cash Risk taken over FIs mgt. & financing of debts arising out of credit sales Specializes in handling & collecting receivables in efficient manner. Sales accounting, debt collection and credit control protection from bad debts & rendering advisory services Release funds tied up in credit & solve problems collection, delays & defaults

MECHANISM
SALE OF GOODS(2) 1 agreement

SELLING FIRM

FACTOR

CUSTOMERS RECEIVABLES

Invoice copy(3)

PARTIES: BUYER SELLER FACTOR

Advance payement/discounting(4)

payments

Final payment after deducting Fess and charges if any(5)

Characteristics of factoring
1.

2.
3.

4. 5.

Period for factoring is 90 to 150 days. Some > 150 days. A costly source of finance compared to other sources of short term borrowings. Factoring receivables is an ideal financial solution for new and emerging firms without strong financials. Bad debts will not be considered Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement.

6.

7. 8.

Cost of factoring=finance cost + operating cost(vary according to the transaction size, financial strength of the customer etc). ( 1.5% to 3% per month depending upon the financial strength of the client's customer). Indian firms offer factoring for invoices as low as 1000Rs 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).

FUNCTIONS OF A FACTOR
Purchase

and collection of debts Sales ledger management Credit investigation and undertaking of credit risk Provision of finance against debts Rendering consultancy services

OTHER FUNCTONS OF FACTOR

A

Factor offers:

Instant Cash Follow up and Speedy Collection MIS Services Sales Ledger Administration. Credit Protection. Advisory Services.

TYPES OF FACTORING
Full service 2. With recourse 3. Maturity(collection) 4. Invoice factoring (only finance) 5. Agency factoring 6. International/cross-border 7. Limited 8. Selected buyer based factoring 9. Selected seller based 10. Bulk or disclosed or notified & Invoice or undisclosed or confidential invoice
1.

BENEFITS
Ready

cash Funds-up to 80% of the factored invoices. Competitive terms to your buyers and improve your sales and ultimately profit. Liquidity will improve and therefore, your production cycle will be accelerated. Appraisal and documentation procedures are made simple and response time is very small. Improves efficiency, credit standing position, cash flows Better position, purchase planning, mgt of receivables impact on balance sheet

 Classified

periodical statement of outstanding

invoices. favorable credit period with liberal grace periods. Minimum-security formalities. Replaces high cost market credit and enables purchases on cash basis availing cash discounts . Each invoice is followed up for payment. Faster collection & Lowest response time. Provides flexibility Helps in boosting the efficiency ratios. Saves the mgt time & effort. Avoid bad debts & off balance sheet finance

FINANCIAL IMPLICATIONS
Impact

on Balance Sheet Off Balance sheet finance Improves Current Ratio, credit standing, efficiency Reduction of cost and expenses Additional source

BALANCE SHEET: PRE-FACTORING SCENARIO

CL & NWC CA

Bank borrowings: Inventory 100 Cash credit(inve) 70 Receivables 80 CC (Receiv) 40 110 Other CL 40 Other current assets 20 NWC 50

current ratio = 1.33:1

200

200

BALANCE SHEET: Post -FACTORING SCENARIO

CL & NWC CA

Bank borrowings: Inventory 100 Cash credit(inve) 70 Due from factor 16 CC (Receiv) - 70 Other CL 16 Other current assets 20 NWC 50 136 136 current ratio: 1.58:1.

LIMITATIONS
Over-confidence-

overtrading

Fraudulent

acts Lack of professionalism and competence, underdeveloped expertise, resistance to change. Rights are uncertain. Sometimes not suitable to enter.

LEGAL ASPECTS
Subject

to terms and conditions Warants receivables are valid, enforceable, undisputed, recoverable Agrees bills non- recourse basis Agrees to service notice of assignments Provide copies of all invoices, credit notes Sole factor submit to factor all sales Grant the factor to hold any balances

 Time

frame for the agreement and mode of transmission Letter of disclaimer from bank To act swiftly Approves and unapproved debts Warrants Disputed debt Inspect firms books & accounts No double financing Genuine trade transaction Personal guarantee Transfer of property section 130

FACTORING SERVICES IN INDIA

Kalyansundaram study group appointed by RBI in 1989. RBI guidelines for factoring services 1990

KALYAN SUNDARAM COMMITTEE RECOMMENDATIONS

Sufficient scope for introduction Export FS additional facility to exporters Commercially viable position within 2.3yrs To all industries and all sectors Mix of various sources of funds <13.5 % pa Raise funds Beginning only select promoter institutions/ groups

of individuals Promoted under zonal basis initially.-4 /5 Suggested SIDBI

 Business

community educated Set up specialised agencies for credit investigations communication IT Proper linkage between banks and factors SSI benefited ECGC Efficient factoring system promoting factoring

RBI GUIDELINES
Banks

cannot directly/departmentally undertake the business of factoring- can invest. But now can Not engage in financing of other companies or other factoring companies. Share <10 % paid up capital & reserves of bank

RBI IDENTIFIED
SBI

western region CANARA BANK south zone PUNJAB NATIONAL BANK northern region ALLAHABAD BANK eastern zone

SBI FACTORS & COMMERCIAL SERVICES (SBI FACS ) LTD

SBI

, UNION BANK OF INDIA AND SIDBI March 1991 promoted commenced operation april 1991. Associate member of factors chain international Amsterdam.- EDIFACT Paid up capital 25 crores, 35% market share

CANBANK FACTORS LTD

Canara Bank, Andhra Bank & SIDBI- August 1992. Paid up capital 10 crorers, 60:20:20

OTHER FACTORS
Foremost

FACTORS LTD : Joint venture with Natinal bank of america (1997)- 20 crores- annual turnover 250 crorepioneered export factoring Global Trade Finance Ltd(GTF):jointly by EXIM bank of india, International Finance corporation & West LB, Germany- Paid up Capital 45 crore

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/in/corp/factserv.htm Foremost Factors Limited: http://www.foremostfactors.net

 Global

Trade Finance Limited: http://www.gtfindia.com Export Credit Guarantee Corporation of India Ltd: http://www.ecgcindia.com Citibank NA, India: http://www.citibank.co.in Small Industries Development Bank of India (SIDBI): http://www.sidbi.in/fac.asp

OPERATIONAL PROBLEMS
Credit

INFORMATION Stamp duty Legal framework Funding Disclaimer certificate Limited coverage

EVALUATION FRAMEWORK- TWO ATERNATIVES TO RECEIVABLE MGT

IN-HOUSE

ITSELF FACTORING SERVICE RECOURSE OR NON-RECOURSE

MANAGEMENT BY THE FIRM

COST ASSOCIATED WITH IN-HOUSE MANAGEMENT

1.

2.

3. 4.

5.

Cash discount Cost of funds in receivables (Avg collection period, cost of bank finance + cost of own funds) Bad debt losses Lost contribution on foregone sales Avoidable cost of sales ledger administration and credit monitoring
Total cost = 1+ 2+ 3+ 4+ 5

COSTS ASSOCIATED WITH RECOURSE & NON- RECOURSE FACTORING

Factoring

commission DISCOUNT CHARGE Cost of long terms funds invested in receivables

DECISION ANALYSIS
Benefits

with recourse : Cost associated with in-house mgt except- bad debt losses Benefits with non-recourse : Cost associated with in-house mgt Net benefit : Benefits - Costs

END OF FACTORING

REFERENCES
http://www.languages.ind.in/factoring.htm

http://www.search4i.com/54454/Directory/

Factoring.aspx Financial Services by M Y KHAN Emerging scenario of Financial services Gordon & Natarajan Financial services by Shashi K Gupta & Nisha Agarwal Websites of factorscompanies

BILL DISCOUNTING

Introduction
a

bill of exchange issued by ABC Company to its client, XYZ Company. ABC Company decides to cash in the outstanding bill in order to make use of the revenue now rather than later. To this end ABC approaches a bank with an offer to sell the bill for 90% of the par value. The bank looks over the transaction and decides the deal is viable. Upon approval, ABC receives 90% of the par value of the bill and instructs XYZ Company to remit payment to the bank. Once the bank receives full payment from XYZ, the deal is considered complete.

 The

bill of exchange (B/E) is used for financing a transaction in goods which means it is essentially a trade related instrument. According to Negotiable Instruments Act, 1881: The bills of exchange is an instrument is writing, containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money, only to, or to the order of, a certain person, or to the bearer of that instrument.

DEFINITION
Acc

to INDIAN NEGOTIABLE act,1881:

The bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directed a certain person to pay a certain sum of money only to or to the order of, a certain person, or to the bearer of that instrument

on presentment to employee. 2. Usance Bill Time period recognized for payment of bills. 3 Documentary Bill These B/E are accompanied by documents that confirm trade has taken place. 4. Clean Bills These Bills are not accompanied by any documents. Interest rate charged is higher than documentary bill.

Types of Bills 1 Demand Bill Payable immediately

Creation of B/E
Two

parties i.e. seller sells goods or merchandise to a buyer. Seller would like to be paid immediately but buyer would like to pay after sometime. Seller draws a B/E of a given maturity on the buyer. Seller (Creditor) becomes drawer of the bill and buyer (Debtor) becomes drawee of the bill. Seller sends the bill to buyer for his acceptance. Acceptor may be buyer himself or third party.

PARTIES INVOLVED
SELLER-Drawer

of the bill.(Creditor) BUYER--Drawee of the bill.(Debtor).

Buyer

is responsible for payment of the bill on the maturity date. (Maturity means date on which payment will fall normally it will be 30,60,90 or 120 days but bill maturing within 90 days is most popular)

DISCOUNTING OF A B/E
The

act of handing over an B/E for ready money is called discounting of a B/E. The difference between ready money paid and the face value of the bill is called Discount.
First:

Hold on the B/E till maturity and take the payment from the buyer. Second:Discount the B/E with a discounting agency.

Discounting of B/E
Holder Hold

of an accepted B/E has two options

on to B/E till maturity and then take the payment from the buyer. the B/E with discounting agency.

Discount The

act of handing over an endorsed B/E for ready money is called discounting the B/E. The margin between the ready money paid and face value of the bill is called the discount

CONT..
The

maturity of a B/E is defined as the date on which payment falls due. Normal maturity periods are 30, 60, 90 or120 days. Bills maturing within 90 days are most popular. Discounting agencies are banks, NBFC, company, high net worth individuals etc

Advantages to investors
Short-term

source of finance. Since it is not lending, no tax at source is deducted while making the payment charges which are very convenient. Rates of discount are better Flexibility, not only in the quantum of investments but also the duration of investments.

 Safety

Funds B/E is a negotiable instrument bearing the signature of two parties considered good for the amount of bill, so he can enforce his claim easily. Certainty of Payment A B/E is a self liquidating asset with the banker knowing in advance the date of its maturity. Profitability The discount on bill is front ended, the yield is much higher than in the other loans and advances, where interest paid quarterly or half yearly.

Advantages to Banks

TYPES OF BILLS
1.

2.
3. 4.

DEMAND BILLNO TIME OR DUE DATE IS SPECIFIED. USANCE BILL/TIME BILL. DOCUMENTARY BILLS.(D/A,. D/P) CLEAN BILLS.

ADVANTAGES
TO INVESTORS: 1. Short-term sources of finance. 2. It is not lending, no tax at source is deducted 3. Rate of discount are better. 4. Flexible TO BANKS: 1. Safety of funds. 2. Certainty of payment 3. Profitability. .

DIFFERENCE
BILL

DISCOUNTING

FACTORING

With recourse. Drawer responsibility of collecting the bill and remitting the proceeds to financing agency. 3. Provision of finance. 4. They can be rediscounted several times before mature. 5. Only individual transaction-oriented.
1. 2.

With or with out recourse. Factor usually undertakes to collect the bills of the client. 3. Provides other services like sales ledger maintenance and advisory services. 4. They cannot be rediscounted but can be refinanced. 5. Provision of bulk finance against several unpaid bill.
1. 2.

SIMILARITIES

BOTH PROVIDES SHORT TERM FINANCE

.

DISCOUNT RATE
L/C

Backed bills 22% per annum

Value = Rs10,000 Discount charges = 10,000x0.22X90/360 = Rs550 Amount received by the client = Rs10,000 Rs550= Rs 9450
Clean

Bills 24% per annum

Discount charges = Rs10,000x 0.24x60/360 = Rs4000 Amount received by the client =Rs10,000 Rs 400 = Rs9600

BILL MARKET SCHEMES

BILL

MARKET SCHEME, 1952 & 1970 RBI effort s for full fledged bill market
Deheja Committee, 1969 Tandon Committee , 1974 Chore Committee, 1980 Vagul Committee, 1985

RBI

guidelines in July 1992

IMPORTANT POINTS
Advances

promissory notes Rediscount usance bills Credit assessment Precautions

FORFAITING
Forfaiting

is a form of financing of receivables pertaining to international trade.

risks and collection problems are fully the responsibility of the purchaser (forfaiter) who pays cash to the seller after discounting the bills.

All

FORFAITING VS EXPORT FACTORING

A

forfaiter, discounts the entire value of the note/bill i.e, forfaiting is 100% financing arrangement of receivables finance but factoring arrangement is only partial. Factoring is essentially a short-term financing deal. Forfaiting is long-term deal. A factor does not guard against exchange rate fluctuations; a forfaiter charges a premium for such risk.

CREDIT RATING

CREDIT RATING Presentation by SWATHI

CREDIT RATNG
Originated

in USA 1860, Henry vannum poor railroad companies(Standard & Poors) Three credit rating agencies are recognized worldwide: Standard & Poors, Moodys Investor Service(1914)(New York , 1900, John Moody), Fitch Ratings(Fitch publishing company dec24th 1913- John knowles Fitch New York City) Standard & Poors :The agencys founding principle was the investor has the right to know.
In 1966, The McGraw-Hill Companies, Inc. acquired Standard & Poors
Fitchs acquired Duff & Phelps Credit Rating Co., headquartered in Chicago, in April, 2000 New York, London

CREDIT RATING
Credit

rating is the symbolic indicator of the current opinion of the rating agency regarding the relative ability & willingness of the issuer of a financial (debt) instrument to meet the (debt) service obligations as & when they arise.

CREDIT RATING AGENCY & RATING

CREDIT RATING AGENCY: A credit rating agency means a body corporate engaged in the business of rating of securities offered by way of public issues. RATING: Rating is defined as an opinion regarding securities expressed in the form of standard symbols or in any other standardized form.

WHY CREDIT RATING?

Extremely useful to.. Investors Corporate (borrowers) Banks & Financial institutions
Debentures, bonds, secured premium notes, certificates of deposits, fixed deposits PSU bonds, preference shares, LPG/KEROSENE dealers, chit fund, real estate developers/builders

ADVANTAGES OF CREDIT RATING

Independent

evaluation Low cost information Investor protection Easily understandable symbols

CREDIT RATING AGENCIES IN INDIA

1.Credit rating information services of India ltd (CRISIL)(UTI & ICICI)January 1, 1988 2.Investment Information & credit rating agency of India (IICRA)(Public Limited Company)16th January 1991(IFC,UTI,LIC,GIC,SBI & 17 banks) 3.The credit Analysis and Research Ltd.(CARE): 1993)investment companies, banks & finance companies) 4.Phelps credit rating India Ltd. JM Financials, Alliance Group and international agency Duffs & Phelps 1995 FITCH rating India Ltd.

REGULATORY FRAMEWORK :
CREDIT RATING AGENCIES REGULATIONS
Their

registration General obligations Restrictions on the rating of securities Procedure for inspection and investigation Action in case of default

REGISTRATION
Registration

with the SEBI is mandatory for carrying on the rating business. Promoter of credit rating agency Eligibility criteria:Minimum Networth of Rs. 5 crore Grant of certificate of registration: Initial payment of Rs. 5,00,000, Renewal fee every 3 years Rs. 3,00,000

GENERAL OBLIGATIONS
Code of conduct Agreement with the client Monitoring of ratings Procedure for review of ratings Internal procedures Disclosure of rating definitions Submission of info to the SEBI Compliance with circulars issued by the SEBI Appointment of compliance officer Maintenance of books of accounts & records Confidentiality Rating process

CREDIT RATING METHODOLOGY

For

Financial

Business risk analysis: Industry risk, market position, operating efficiency, legal position Financial Risk analysis: Accounting quality, earning prospects, cash flows, flexibility, interest and tax sensitivity Management risk analysis
Regulatory and competitive environment Fundamental analysis: Capital adequacy, esources, asset quality, liquidity mgt, profitability and financial position, interest and tax sensitivity

Manufacturing companies:

services sector:

RATING PROCESS
1.

New issue rating:

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

2.

Initial contact introductory meeting Supply of data Rating exercise Analysis of new facts & enlisting new unresolved questions Meeting Preparation of rating profile Discussion & vote to determine rating. Notification of rating Issuer appeals against rating formal notification rating surveillance system

Review of existing rating: Analysis of new data , locating possibility of rating , credit watch notification, detailed analysis meeting

SERVICES OFFERED BY ICRA Ltd

Rating

services Information services Advisory services

RATING SERVICES
Credit

Assessment General Assessment Structured Finance Rating Claims Paying Ability Rating (CPRs) Corporate Governance Rating Line of credit rating Credit assessment for small & medium scale industries

INFORMATION SERVICES
Earnings

Prospects & Risk Analysis (EPRA) Investment Information Publications Customized Research Corporate Reports Grading Services

ADVISORY SERVICES
Strategic

Consulting Risk Management Area Regulatory Practice Transaction Practices Banking & Financial Services Manufacturing & Service sector Power sector

CONCLUSION
Default

in payment of interest Non-banking companies maturities more 18mths rated Rating of municipal bonds,govt borrowings, deposits rated Several constraints Strategic alliances with international agencies.

REFERENCES
http://www.kazakhstaninvestment.com/cred

it-rating-2.html Financial services by MY Khan Emerging scenario of Financial servicesGordon & natarajan

END OF UNIT V

The following conditions : met to give full effect to the factoring arrangements
1.

The invoice, bills other documents drawn by the seller should contain a clause: as referred to or mentioned in might be factored.

Payments arising out of the transaction

The seller should confirm in writing to the factor that all the payments arising out of these bills are free from any encumbrances, charge, lien, pledge, hypothecation or mortgage or right to sell-off or counter-claim from another etc.

2.

TERMS & CONDITIONS

Selling

limits for the client Recourse to the client in case of nonpayment by the trade customer conditions Details reg. payment for his services Interest to be allowed to the factor Limit of any overdraft facility and the rate of interest to be charges

3. The

seller should executive a deed of assignment in favor of the factor to enable him to recover the payment at the time or after default.

4.The seller should confirm (by a letter of confirmation) that all conditions to sell-buy contract between him and the buyer have been compiled with and the transactions complete;
5. The seller should procure a letter of waiver from a bank in favor of factor in case the bank has a charge over the assets sold out to buyer and the sale proceeds are to be deposited in the account of the bank.

THE BUYER
Negotiates

terms Receives delivery + invoice + instruction Make payment in time/gets IN time / default- legal process

THE SELLER
MOU

with the buyer/agreement 80% or more payment Balance payment after deduction of service charges.

The factor
Agreement

with the seller On receipt of copies of sale document pays 80% of the price of the debt Receives payment from buyer on due dates and merits the money to seller after usual deduction;

COST OF FACTORING
Finance

charge is computed on the pre-payment outstandings in your account at monthly intervals. Factoring can be cheap source of funds, provided you organize your drawals. Service/Handling charge is a nominal charge levied to cover the cost of services viz. collection, sales ledger management and periodical MIS reports. It ranges from 0.1% to 0.2% on the total value of invoices factored/ collected by us. The tax payable on Service/Handling charges is also recovered from