This article explains in brief the Factoring Process and Types of Factoring. We recommend you to go through Factoring Introduction and utility and importance of factoring to get a better understanding of Factoring Process and Types of Factoring.
Factoring Process
The factoring process can be summarized in the activities of all the parties (client, buyer, factor) in a factoring agreement. Various tasks performed by the parties in a factoring process are:
Buyer –
- Enters into an agreement, negotiates and decides terms and conditions of sale agreement
- Takes delivery with invoice bill and instructions to make payment to the factor on due date
- Makes a payment or asks for extension. In case of default the buyer may face legal actions.
Seller –
- Enters into a contract of sale of goods on credit as per purchase order
- Sells goods as per contract
- Send copies of invoice, delivery challan along with goods to the buyer with instructions for making payment to factor
- Provides warranty that the customer has received the merchandise without any counter claim or disputes
- Sells the receivable received from the buyer to a factor and receives 80% or more in advance
- Receives the balance after paying the service charges
Factor –
- Enters into an agreement with the seller for rendering factor services i.e. collection of receivables
- Advises client on credit worthiness of potential clients
- Pays up to 80% advance on receiving sales documents
- Renders statement of accounts at periodic intervals to client and buyer
- Receives payments from the buyer and pays balance after deducting commission
Types of Factoring Agreements
(1) Recourse and Non-recourse factoring
These types of factoring depend upon the type of credit protection provided by the factor.
In recourse factoring, the factor does not assume credit risks associated with the receivables and hence factoring does not include protection against bad debt. In such a factoring agreement the factor purchases the receivables arising out of sale of goods and provides all collection and maintenance services, but in case of non-payment by the buyer the client (seller) has to refund to money back to the factor.
In non-recourse factoring, the loss arising out of irrecoverable receivables (non-payment) is borne by the factor, he can only charge high commissions as compensation but cannot claim a refund. Hence, the client is protected against bad-debts. The additional fee charged as a premium for risk bearing is called DEL CREDERE Commission.
(2) Advance Factoring
In these types of factoring, the factor pays a pre-specified portion ranging from ¾ to 9/10 of the factored receivables in advance, the balance being paid upon collection or on the guaranteed payment due. A drawing limit is made available to the client but the client has to pay an interest on the money he withdraws between the date of withdrawal and date of collection of receivables.
(3) Bank Participation Factoring
In such a factoring agreement, the bank (factor) provides an advance to a client for financing a part of the factor reserve. Factor reserve is equal to Factor debt less advance payment by factor.
(4) Maturity or Collection Factoring
In maturity factoring, the factor does not make an advance payment to the client. The payment is made either on the date of collection or on a guaranteed payment date. The guaranteed payment period is fixed taking into considerations –
previous experience with the client
and period for slow collection
(5) Full Factoring
It is the most comprehensive form of factoring, also known as old line factoring. A full factoring agreement involves a plethora of services provided by the factor to the client including –
- Collection of receivables
- Protection against bad-debts
- Sales ledger administration
- Short Term finance
(6) Disclosed and Undisclosed Factoring
In disclosed factoring, the name of the factor is disclosed in the invoice by the supplier (client) of the goods asking the buyer to make a payment to the factor. The supplier may or may not continue to bear the risk of non-payment.
In undisclosed Factoring, the name of the factor is not disclosed although he maintains the sales ledger of supplier (client). Realization of business transactions are done in the name of supplier while the factor has all the control.
(7) Domestic and Export/Cross border/international factoring
These types of factoring depend upon the domicile of the parties involved in a factoring agreement.
In domestic factoring the parties involved – customer (buyer), client and factor domicile in the same country.
In Export/Cross border/international factoring the parties reside in different countries. The parties involved are –
- exporter (client)
- importer buyer
- import factor
- export factor