Factoring

Meaning: Factoring is a financial service in which a "factor" provides a bundle of services to a client firm. These services include:

• (a) Discounting of bills and collection of debts: The client's receivables (arising from the sale of goods or services) are sold to the factor at a discount. The factor then takes over all credit control and debt collection from the buyer and protects the firm against bad-debt losses. There are two methods:
  • Recourse factoring — the client is not protected against the risk of bad debts.
  • Non-recourse factoring — the factor bears the entire credit risk; the full invoice amount is paid to the client even if the debt turns bad.
• (b) Providing credit-worthiness information: Factors hold large amounts of data on firms' trading histories. This helps clients avoid dealing with customers who have a poor payment record, and factors may also offer consultancy in areas such as finance and marketing. The factor charges a fee for its services.

Indian context: Factoring appeared in India only in the early 1990s, following RBI initiatives. Providers include SBI Factors and Commercial Services Ltd., Canbank Factors Ltd., Foremost Factors Ltd., State Bank of India, Canara Bank, Punjab National Bank and Allahabad Bank, along with many non-banking finance companies and other agencies.

Merits

• Cheaper than raising funds through means such as bank credit.
• Accelerated cash flow lets the client meet its liabilities promptly as they arise.
• Flexible and gives a definite pattern of cash inflows from credit sales; provides security for a debt a firm might otherwise be unable to obtain.
• Creates no charge on the firm's assets. …