Factoring 1. Definition of the Factoring Factoring is a financial transaction whereby a business sells its accounts receivables (i.e.

Invoices) to a third party (called a factor) at a discount As above definition the factoring term can also described as below, In "advance" factoring, the factor provides financing to the seller of the accounts in the form of a cash "advance," often 70-85% of the purchase price of the accounts, with the balance of the purchase price being paid, net of the factor's discount fee (commission) and other charges, upon collection from the account client. In "maturity" factoring, the factor makes no advance on the purchased accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being purchased in the batch. There are some important points that we should consider regarding this financial tool, they can be list dawn as below, Factoring also known as Accounts Receivable Financing. it is the practice of selling your accounts receivable (invoices) at a discount to another company. You get the money from the company that you sold your accounts receivable to and they become responsible for collecting on the invoices. It is a collection and finance service designed to improve your cash flow, turning your credit sales invoices into ready cash unlike any other financing services it normally requires no collateral It can take time to collect an invoice, so when a company finances its accounts receivable, they are getting their money faster and without the hassle of the collection process. As in businesses, it is important to free up working capital so that the money can be invested into new equipment, used to pay bills, or used toward payroll.

2. Who may need factoring?

Mainly for trading business Businesses which are growth oreanted Bussinesses having a large portfolio of debtors/ post dated cheques

Selling fast moving products( not on a sale or return basis/ consignment basis) Non perishable products

These types of business needed csh in hand at every possible time, so they are the most needed business people that seekink for financial tool factoring. So they can use this tool for supply money immediate for day to day business and avoid unnecessary late on other payments for supplyers.

3. Factoring services providers

Mainly licensed financial companies which has enough potential to take risk in factoring envolved in this field. In sri lanka following companies are mainly envolved in this business, 1. 2. 3. 4. 5. 6. Lanka Orix Factors Commercial Factors Nations Factors Commercial bank LB Financing Oreant Factors

4. Enterprises involved in factoring

There are some enterprises that cannot enter to the factoring field such like, Sale or return basis goods can be returned / invoice rendered value less Consignment sales Payments in stages construction Invoicing in advance (maintenance) paid in advance but services provided in a period of time Contra trading debtor is also a supplier resulting in setting off balances Retentions (construction industry) No post invoice contractual obligations

Other enterprises who needed to facilitate their business with immediate tangible money can enter the factoring

5. Factoring process

As this diagram we can get a basic idea of factoring process. In below the steps are mentioned regarding factoring briefly. The client sells the goods on credit basis to customers The client offers the assigned invoice to the factor. The factor makes a pre-payment up to 80% of the value of the assigned invoice. The factor notifies the customer sending a statement of account Customer remits the amount due to the factor

 Factor makes balance 20% of the invoice value to the client when the account is collected.

6. Functions of the factoring

Finance Debt Administration Credit Risk Advisory Services

1. Finance

The factor provides advance money to the client against outstanding debt of about 80% and the balance minus commission on maturity. The factor acts as a source of short-term

2. Debt administration

Under this, the responsibility of the factor is to take care of all the functions relating to the maintenance of the sales ledger on open item basis which should clearly show all the outstanding invoices and the unallocated cash. The factor sends monthly statements of accounts and informs the client about the progress of collection of debts from time to time and also informs him/her about the debts collected and overdue accounts.

3. Credit Risk

One of the important functions of the factoring is credit protection. The factoring organization is required to ascertain the credit worthiness and feasibility position of several buyers and accordingly advice the client. Hence, the client is guided by he factors advice in this regard, under which the factor reduces the risk of loss through bad debts.

4. Advisory services

The factor is also able to provide advisory service on credit and financial dealings and access to extensive credit information.

7. Types of factoring

Notified and undisclosed factoring Recourse and non-recourse factoring Advance and maturity factoring Invoice factoring Buyer-based, seller-based and selective factoring Export factoring

1. Notified and undisclosed factoring In case of notified factoring, the customer is informed about the assignment of the debt to the factoring agents and is also asked to pay the dues to the factor instead of to the firm.

On the other hand in the undisclosed factoring, the factoring arrangements is not disclosed to the customer but the customer is required to make the payment to the changed address. This is also known as non-notified factoring or confidential factoring.

2. Recourse and non-recourse factoring

In recourse factoring, the factor purchases the receivables on the condition that the loss arising on account of irrecoverable receivables will be borne by the client. In non-recourse factoring the bad debts are borne by the factoring agent. Since the factor bears the loss arising on account of irrecoverable debts, the factor charges a higher commission.

3. Advance and maturity factoring

In advance factoring, the factor provides an advance varying between 75-85% of the value of receivables factored and the balance is paid upon collection or on the guaranteed payment date. In maturity factoring, the factor makes the payment on a guaranteed payment date or on the date of collection.

4. Invoice factoring

Here the factor simply provides finance against invoices without undertaking any other functions

5. Buyer-based, seller-based and selective factoring

In most case, the factor is acting as an agent of the seller. But under this type, the buyer approaches a factor to discount his bills. Thus the initiative for factoring comes from the buyer end

6. Export factoring This is also known as international factoring or cross border factoring. Export factoring houses deal with export sales and provide financial service, collection service, advisor service, and service for completing legal formalities pertaining to export.