Factoring is a continuing arrangement between a financial institution (the Factor) and a business concern (the client), selling goods or services to trade customers. The Factor purchases the client’s book debts (account receivables) either with or without recourse to the client.
The purchase of book debts or receivables is central to the functioning of factoring. The supplier submits invoices arising from contracts of sale of goods to the Factor.
The Factor performs at least two of the following services:
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a. Financing for the seller, by way of advance payments.
b. Maintenance of accounts relating to the account receivables.
c. Collection of account receivables.
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d. Credit protection against default in payment by the buyer.
The buyer is informed in writing that all payment of receivables should be made to the Factor.
Different Models of Factoring:
Export Factoring can be done based on two distinct models:
1. Two-factor system
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2. Direct factoring
(1) A two-factor system:
It essentially involves an export factor in the country of the seller (exporter) and its correspondent factor (import factor) in the country of the debtor (importer). The correspondent factor typically performs a mutually agreed set of services for the export factor. It could be any one or both the below mentioned services:
A. Credit Guarantee Protection:
The import factor undertakes to pay the export factor in the event the importer fails to pay by a specified period after due date. The import factor sets up limits on buyers present in that country and the export factor discounts invoices for its customers based on these limits. The credit guarantee protection covers insolvency/protracted default of buyer. However it does not cover trade disputes.
B. Collection Services:
The import factor undertakes to follow up with debtors for payment and in cases where payment is not forthcoming they would be in a position to detect early indications as they would be based in the same location and would be familiar with local business intelligence as well as practices.
The factoring quotes given by various import factors would differ depending on their location and comfort regarding the overseas buyer. In this situation, the export factor would need to monitor its correspondent relations with various import factors across the globe.
Also, the possibility of undertaking any factoring business by the export factor would be depend on the response of the import factors for each transaction.
(2) Direct Factoring with credit insurance and tie up with a global collection agency:
Factoring can also be offered by availing credit insurance for the entire factoring portfolio. Credit insurance will cover insolvency/protracted default by the buyer as well as country risk but it would not cover trade disputes. The credit insurer will set up limits on overseas buyers and based on these limits export bills would be discounted.
Thereafter, details of the invoice would be passed on to the collection agency that will follow up for payment with the overseas buyer. In case the overseas buyer does not respond, the collection agent can monitor potential default cases, so that credit insurer can be informed in advance.
Using services of a collection agency could reduce significantly the delays and to some extent the uncertainty in payments from overseas buyers.