Factoring involves the purchase of book debts or receivables of either a commercial organization or industrial unit. The Factor (the institution that purchases the book debts) also takes over the responsibility of:
a. Maintaining the sales ledger
ADVERTISEMENTS:
b. Covering the risk involved in recovery of the debts and
c. Prepay amounts due on account of sales.
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The Factor provides valuable information on the creditworthiness of various organizations or individuals with whom the company has dealings or proposes to have dealings. It involves the provision of credit control, protection and credit collection services to the client.
The Factor usually approves a list of persons or organizations as approved customers on whom the Factor’s client can raise bills up to approved limits. The relationship between the Factor and the client (the unit from whom the bills or invoices are purchased) is a continuing relationship. Although the banks do provide bill discounting facilities, yet there is a difference between Factoring and Bill discounting. These differences are:
ADVERTISEMENTS:
a. Banker discounts the bill within certain limits and within the tenor period of the bill. Immediately after the tenor period, the bill, if remaining unpaid would be removed from the cover and this causes shortage of working capital, though temporarily. Further, the bank does not take over the credit risk since the bill discounted in most cases is ‘with recourse’ to the drawer (the right to claim bad debts from the account holder for whom the bill was discounted).
b. The banker does not also take the responsibility of collecting dues from the customers on whom these bills are drawn.
c. The banker does not also provide information on the creditors.
In the case of factoring, the Factor does due diligence on the client’s customers and then alone offers a line of credit to the client. Such limits are also fixed customer-wise for certain mutually agreed periods for which the Factor will purchase the receivables. In the invoice so drawn, the client indicates that the dues on the invoice are assigned in favor of the Factor and, hence, the customer is directed to pay the dues on due date directly to the Factor.
ADVERTISEMENTS:
The Factor pays up-front major portion of the invoiced amount that is supported by the proof of dispatch of goods and their receipt by the client’s customers. The balance will be paid on realization of the bill amount in full. The Factor will charge the client for the services offered.
If the Factoring is done ‘without recourse’ basis, then even if the customer fails to pay on the due date the Factor will take over the risk of non-collection and will not recover the amount from his client. It is but natural that ‘without recourse’ sales attract higher price.
Factors are very useful source of working capital, although they have not become popular due to the legal lacunae in ‘without recourse’ acceptance. This reduces tremendously pressure on cash flow of the unit. SBI Factors cover west and north while Can Factors managed by the Canara Bank covers south. Both the Factors have not proved successful thus far in the SME sector.