Credit Factoring is an asset sponsored mode of financing (three-way agreement between the buyer, seller as well as the factor), by which the account receivables are allocated to the third party which is known as the factor for a discount, liberating the tied-up capital, also enabling financial liberty to the organization. However, foundation of factoring goes back to the 14th century in England. Previously, factoring was restricted to only textile & garment businesses, however later it was spread across the several industries as well as markets.

Besides, factoring has been very well defined as, an ongoing legal association between a financial institutions (known as the “

Credit Factoring is an asset sponsored mode of financing (three-way agreement between the buyer, seller as well as the factor), by which the account receivables are allocated to the third party which is known as the factor for a discount, liberating the tied-up capital, also enabling financial liberty to the organization. However, foundation of factoring goes back to the 14th century in England. Previously, factoring was restricted to only textile & garment businesses, however later it was spread across the several industries as well as markets.

Besides, factoring has been very well defined as, an ongoing legal association between a financial institutions (known as the “factor”) and a business entity (who is the “client”) vending goods or else offering services to trade customers, through which the factor procures the client’s book of debts either with or without option to the client, also in association thereon regulates the credit extended to the customers as well as administers the sales ledger.

Further, Factoring Business as defined in Factoring Act, 2011 states that it is the business of acquisition of receivables of assignor via accepting the projects of such account receivables or financing, either by mode of making loans or else advances or by any other mode alongside the security interest for any receivables. Nevertheless, credit services offered by banks in the normal mode of business against security of receivables as well as any action commenced as a commission agent or if not for sale of agricultural products or else goods of any sort.

Although Europe delivers largest books across the globe, factoring business in Asia has been budding speedily since past few years. Moreover, factoring is a financial alternative for the administration of receivables. In simple words, it is known as the conversion of credit sales into cash.

What is the Mechanism of Factoring?

In the process of factoring, a financial institution- also known as factor, purchases the accounts receivable of an organization (Client) as well as typically pays them around 80% of the amount instantly over the agreement. Then, the remaining amount i.e.20% is paid by the factoring company to the client as soon as the customer clears the debt. Also, debt collection from the factor or client depends upon the type of factoring. Different types of factoring has also been described below. Moreover, in factoring account receivable can either be for a product or a service. For Instance, factoring against goods bought, factoring for the construction services generally for government contracts where the probabilities of receiving payments are higher and factoring against the medical insurance.

Characteristics

• Generally the spell for factoring is approx. 90days-150 days. However, a few factoring companies permit even beyond 150 days.
• Factoring is deliberated as an expensive source of finance as compared to other sources of short-term financing.
• Factoring receivables is a superlative financial solution for any new & emerging business without robust financials, since credit worthiness is assessed on the basis of the financial strength of the consumer.
• Bad debts would not be deliberated for factoring.
• Credit rating is not compulsory. Nevertheless the factoring companies generally perform credit risk analysis prior getting into the agreement.
• Factoring is a technique of bad balance sheet financing.
•  

Fee for factoring

Fees charged for factoring is the sum of finance cost as well as operating cost. But the cost of factoring varies depending upon the size of transaction, defaulting history of customers, monetary strength of the customer etc. Also, factoring cost varies from around 1.5% - 3% on monthly basis depending on the monetary strength of the client's customer.

Types of Factoring

• Recourse & Non-recourse

Within recourse factoring type, the factor turns towards the client (seller), if the receivables turns out to be bad, i.e. if in case customer doesn’t pay on the maturity. The possibility of bad receivables remains along with the client and the factor doesn’t take responsibility for any risk related with the receivables. Also, factor offers the service of receivables collection, nevertheless doesn’t cover the jeopardy of the buyer failing to pay the debt. However, factor can recuperate the funds from the seller (client) in an instance of such a default and the vender accepts the jeopardy associated with the credit as well as creditworthiness of the buyer.

Within non-recourse factoring type, the factor accepts the possibility of non-payment by the client's customers. The factor can’t demand any unsettled amount from the client (seller). The amount or fees charged for the non-recourse factoring services are more than that of recourse factoring. The factor accepts the jeopardy of non-payment over maturity as well as consequently takes an added fee known as a del credere commission.

• Domestic & Export Factoring

Domestic & export factoring differ in terms of the number of parties involved in it. Within domestic factoring there is the involvement of 3 parties (seller, buyer & factor) whereas, within export factoring there is the involvement of 4 parties (seller, buyer, domestic factor & international factor).

Also, factor is the mediator between seller and buyer in domestic factoring and all the three parties are sited in same country. But, in export factoring there are subsequently 2 factors involved in the transaction and is stated as the two-factor structure of factoring.

• Disclosed & Undisclosed Factoring

Within disclosed factoring type, the seller informs the buyer of the factor's name in the invoice, telling them to clear the payment of the factor on the due date.

Within, undisclosed factoring type, the seller doesn’t inform the buyer about the existence of factoring deal, thus the name of the factor is not revealed over the invoice

• Full Factoring & Limited Factoring

Within, full factoring type, the factor offers almost all the services like keeping the sales ledger, collection, credit control & credit insurance. This is also termed as Conventional Factoring or even Old Line Factoring. Also, the factor provides other services depending upon the requirements of the client such as keeping accounts, maturity-wise bill collection, advance granting of limits to a limited discounting of invoices on a selective basis. Within limited factoring type, the factor opts for a limited number of invoices to be the matter of factoring agreement along with the client (seller).