Factoring | Trade Samaritan

Factoring

Today, almost every industry can profit from factoring. Factoring is also known as Receivables finance and is an export finance instrument available in international trade market.

Factoring is a complete financial package that combines working capital financing, credit risk protection, accounts receivable bookkeeping and collection services.  Factoring involves discounting of short-term receivables (up to 180 days). The exporter transfers title or the right to receive a payment to a factoring house for cash at a discount (deduction) from the face value. A factoring house or a factor is a bank or financial institution that extends finance to the exporter by purchasing the invoice. Transaction fee is deducted upfront from the cash paid to the exporter. It allows an exporter to ship or trade on open account more easily as the factor assumes the financial liability of the importer to pay and handles collections on the receivables. Factoring houses most commonly work with exports of consumer goods. Today, factoring platform is completely automated and exporters can access their ledgers and outstanding balances with the factoring house very easily.

World factoring volume for the year 2012.

Factoring volume

World Factoring volume Pie

Factoring and Forfaiting both are export finance instruments however are different from each other on various parameters.

  1. Tenor: Factoring is short term and usually offered to Small and Medium sized enterprises (SMEs) against their short termed exports. And forfaiting includes an extension of high value and long term maturity finance which is availed by larger corporates against their turnkey projects and large value exports such as capital goods and equipment.
  2. Transfer of risk: Forfaiting is selling of medium and long term accounts receivable at a discount on a ‘without recourse’ whereas Factoring is offered on both with recourse and without recourse terms.
  3. Arrangement: In Forfaiting, receivables are normally guaranteed by the importer’s bank, which allows the exporter to take the transaction off the balance sheet to enhance key financial ratios. In factoring, the due diligence and evaluation of limits with respect to the buyer is done via Import factoring house.
  4. Nature of transaction: Factoring transactions are mostly open account transactions whereas forfaiting is more commonly done against LC (Letter of Credit) backed transactions or documentary collections.

Factoring is closely linked to open account transactions where exporters sell goods on open account on credit terms and discount the underlying invoice for ready and instant cash.

Factoring process flow

The technical process flow of a factoring transaction is quite similar to that of a forfaiting transaction, however here the Export factor is required to establish a relation with an import factor in order to evaluate the buyer/importer and collect the proceeds on the due date on its behalf. Upon approval, the export factor pays 70%-80% of the invoice value upfront to the exporter and balance 20%-30% is paid upon realization/collection of the proceeds from the buyer.

Factoring process

Benefits

  1. Provides flexibility to exporters to trade on open account with credit terms
  2. Incremental business as exporters are able to sell on credit terms
  3. Avoid credit losses if ‘without recourse’
  4. Collection of payment and related book keeping function is handled by the factoring house
  5. Automated platforms and reports
  6. Best suited for short term exports to fill the cash flow gap
  7. 70%-80% of the invoice value is paid upfront in cash (less the fee) by the factoring house and balance is reimbursed upon collection.

Factoring service on an overall basis is extremely beneficial to the exporters except that at times exporters may find the factoring fee costly especially for low value transactions. The factoring house may refuse the facility for new-to-export companies as they may have mandates such as submission of statements relating to yearly export sales. Also this facility may not be extended for a one-time deal and is more commonly offered for continuous sales and approved buyers.

Textiles, clothing and (consumer) electronics are the most popular but manufacturers of industrial and farm equipment, office equipment and processed food are increasingly turning to factoring.

Factoring is now universally accepted as vital to the financial needs of small and medium-sized businesses.

Factors Chain International (Netherlands) and International Factors group (Belgium) are the two principal organizations promoting factoring facilities across the globe. Exporters keen on availing this facility can obtain information from websites on factoring houses located in their city/country. It has the support of government offices and central banks throughout the world. With increasing popularity and the number of factoring houses across the globe, factoring has become one of the most competitive products in the world trade market.

 

References

Factors Chain International
International Trade Administration

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