LESSON 13: FACTORING – THEORETICAL FRAMEWORK
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Finance Maintenance of accounts Collection of debts Protection against credit risks”.
To understand the Concept of Factoring. Methodology of Factoring and Forfeiting. Types of factoring.
Receivables constitute a significant portion of current assets of a firm. But, for investment in receivables, a firm has to incur certain costs such as costs of financing receivables and costs of collection from receivables. Further, there is a risk of bad debts also. It is, therefore, very essential to have a proper control and management of receivables. In fact, maintaining of receivables poses two types of problems; (i) the problem of raising funds to finance the receivables, and (it) the problems relating to collection, delays and defaults of the receivables. A small firm’ may handle the problem of receivables management of its own, but it may not be possible for a large firm to do so efficiently as it may be exposed to the risk of more and more bad debts. In such a case, a firm may avail the services of specialised institutions engaged in receivables management, called factoring firms. At the instance of RBI a Committee headed by Shri C. S. Kalyan Sundaram went into the aspects of factoring services in India in 1988, which formed the basis for introduction of factoring services in India. SBI established, in 1991, a subsidiary-SBI Factors Limited with an authorized capital of Rs. 25 crores to undertake factoring services covering the western zone
The above definition, however, applies only to factoring in relation to supply of goods and services in respect of the following: i. To trade or professional debtors ii. Across national boundaries iii. When notice of assignment has been given to the debtors. The development of factoring concept in various developed countries of the world has led to some consensus towards defining the term. Factoring can broadly be defined as an arrangement in which receivables arising out of sale of goods/ services are sold to the “factor” as a result of which the title to the goods/services represented by the said receivables passes on to the factor. Hence the factor becomes responsible for all credit control, sales accounting and debt collection from the buyer (s).
Glossary of Terminology
The common terminology used in a factoring transaction are as follows: i. Client He is also known as supplier. It may be a business institution supplying the goods/services on credit and availing of the factoring arrangements. ii. Customer A person or business organisation to whom the goods/ services have been supplied on credit. He may also be called as debtor. iii. Account receivables Any trade debt arising from the sale of goods/ services by the client to the customer on credit. iv. Open account sales Where in an arrangement goods/ services are sold/supplied by the client to the customer on credit without raising any bill of exchange or promissory note. v. Eligible debt Debts, which are approved by the factor for making prepayment. vi. Retention Margin maintained by the factor. vii. Prepayment An advance payment made by the factor to the client up to a certain percent of the eligible debts.
Meaning and Definition
Factoring may broadly be defined as the relationship, created by an agreement, between the seller of goods/services and a financial institution called .the factor, whereby the later purchases the receivables of the former and also controls and administers the receivables of the former. Factoring may also be defined as a continuous relationship between financial institution (the factor) and a business concern selling goods and/or providing service (the client) to a trade customer on an open account basis, whereby the factor purchases the client’s book debts (account receivables) with or without recourse to the client - thereby controlling the credit extended to the...