FACTORING IN FINANCE
1 . INTRODUCTION:
Factoring or Invoice Factoring is one of the methods in Alternative Financing in which the business sells
or pledges its accounts receivables to a Finance Company – called Factor – at a discount or a fee in
order to get immediate cash and thus circumvent the credit period allowed for customers(debtors).
Though Factoring assumes several forms depending on the amount and risk involved, in its basic form,
Factoring works as follows:
Assume Firm A( ie; the ‘Business’ ) is the seller and Firm B the Customer /Client . Also assume the credit
period agreed is 60 days for the invoices raised by A to B.
Business exigencies forces A to have adequate cash in hand as working capital as well as expansion of its
business. Further, circumstances or the given situation precludes getting conventional source of finance
at short notice.
Hence A approaches a third party finance Co or the Factor – Firm C – and pledges or sells the
outstanding receivables from B.
The Factor C gives the seller A immediate cash – 80 to 90 % of the invoice amount in most cases- and
then takes the responsibility of collecting the invoice amount from buyer B.
2 . TERMS / LINGO
Since this type of financing is different from conventional modes, there are a few terms specific to the Factoring trade and hence it helps these are familiarized before we proceed further on the topic:
3.FACTORING – RATIONALE
Factoring is resorted to Companies in the following categories:
- Start-ups whose growth prospects are extremely high and who do not have access to conventional source of funds.
- Businesses that needs faster liquidity who can’t wait 60- 90 days for receivables
- • Firms who had poor track record earlier( and hence getting credit from conventional sources difficult) but suddenly have become profitable and short to medium outlook are rosy.
- Seasonal businesses ( Eg: in agro-commodities )
Though the absolute value of cost of capital ( CoC) for Factoring facility would be higher than CoC for conventional credit, for most of these companies the ‘opportunity cost’ ( for want of cash for working capital and expansion) would turn out to be far higher and hence Factoring becomes the ideal source of realizing the invoices as soon as a deals are firmed up.
4. CATAGORIES / TYPES
Though there are a few variations in Factoring, the most significant ones are Recourse and Non-Recourse Factoring modes.
In Recourse Factoring, the Factor does not take the risk of possible defaults by the debtor, while in Non-recourse Factoring, the entire risk of collecting the payment from the debtor is Factor’s responsibility. Non-recourse Factoring , however comes with significant additional cost towards coverage of debtor payment default and hence is resorted to by those sellers who cannot afford to take risk of payment defaults.
5. FACTORING – BROAD PROS AND CONS
Facilitate business to quickly convert receivables into cash-without waiting for the ‘mandatory’ credit window to close.
From an accounting perspective, Factoring is not deemed to be debt and does not increase the liability side of the balance sheet.
In certain specialized Clients like Govt services, Factoring facility can reduce payroll expenses since complex paperwork towards qualification of invoices will be taken care of by the Factor.
At an absolute or standalone manner, cost of Factoring will normally be more than Conventional Credit facilities. However, if ancillary cost like loss of opportunity are Factored into, the scenario can tilt in most cases.
Perception about Company image: In general, it is a general perception that the Cos engaging Factoring facility must be facing financial difficulties.
Many Clients( customers) would prefer to deal with the seller directly from a ‘comfort’ standpoint rather than dealing with a Factor, which is essentially a third party.
6. RULES & REGULATIONS
Global: International Institute for the unification of Private laws(UNIDROIT, http://www.unidroit.org ) had first adopted a resolution in 1988 towards ”uniform rules to provide a legal framework that will facilitate international Factoring, while maintaining a fair balance of interests between the different parties involved in Factoring transactions”. The rules came into force in 1995. However, as per the information available in public domain( http://www.unidroit.org/status-1988-Factoring), till 2015 only 19 countries have adopted these.
India: Govt. of India formally commenced regulating Factoring facility by bringing out the Factoring Regulation Act, 2011. The Act sets out broad contour of the rights and responsibilities of the various stake-holders involved.
Reserve bank of India followed up in 2012 with setting out specific rules by recognizing Factoring as a distinct entity under NBFC ( “NBFC-Factor”) under “NBFC-Factor(Reserve Bank) Directions,2012”
The Directions sets out minimum requirement of NOF( Net Owned Fund), minimum threshold of assets in Factoring business etc.
7. FACTORING VOLUME ACROSS THE GLOBE
The overall global volume of factoring post global melt down is pictorially shown below:
It can be seen that while the volume has been plateauing from 2014 onwards.
However, there has been wide variations in the volume across major economies, as can be observed from the following pie-chart
In Europe, which contributes more than half the global volume, the major players re :
In Asia pacific, by far, the largest contributor to factoring volume is China ( >50%). Other major players are Singapore, Australia and Japan.
8. GLOBAL FACTORING BUSINESS : WHY THE GROWTH PLATEUED?
As can be observed from the chart in earlier page, the overall growth in global factoring business has been sluggish for the past three years.
However, there is a subtext to this. While many European Economies contributed to positive growth(between 3 to 13 %), by far the biggest laggard has been Asia pacific region with significant pullback observed from China, owing primarily to sluggish economic growth.
In general, however, it is reported by FCI(www.fci.nl), a global body representing Factoring business, tight regulations in many economies still appear to be holding back the growth of factoring and the global body has been continuously making efforts to have a more improving regulation is
9. CURRENT STATUS OF FACTORING IN INDIA
FCI reports that, India had 11 Companies engaged in Factoring business in 2016 with a combined volume of €3.9B of which domestic business constituted about 70%. This is a minuscule fraction of the global volume (~€ 2400 B). Just to compare the volume in China for the same period has been around € 300B. Even on a per capita GDP basis, China’s volume is way above that of India.
Looking at the volumes in recent years, it is apparent that the Factoring volume in India has been almost stagnant for the past few years in view of various regulatory restrictions on the trade in India. It appears that while RBI has addressed the issue and eased some of the original regulations. Nevertheless, overall it appears the Factoring as a business in India is yet to wriggle out of the slow growth trajectory.
CEO, ERGONOMIX INTELLECTUAL CAPITAL ASSETS