Domestic Factoring: Concept, Policy and Procedural Issues

1. Domestic Factoring: Concept, Policy and Procedural Issues Mohammad Shafiullah Lecturer, BIBM

2. Factoring Factoring is a flexible alternative to traditional forms of funding. It allows you to respond quickly to changes in market conditions and matches your cash flows with your business requirements, thereby facilitating increased production and sales.

3. Parties Involved Factoring • Seller • Debtor • Factor

4. Factoring- What It Means? Is a contract between ‘the Supplier’ and ‘the Factor’ wherein: the Supplier assigns receivables to the Factor Notice of Assignment of receivables is given in writing to the debtors. the Factor performs atleast two of the following services: • Financing by way of prepayments against invoices • Sales Ledger Maintenance • Collection of Receivables • Credit Protection against Bad Debts

5. Factoring When Best Suited ? Situation Of Open Account Sales

6. Factoring When Best Suited ? Involving Continuing Relationships

7. Factoring When Best Suited ? Assignment Of Whole Turnover

8. Factoring vs. Accounts Receivables Financing Factoring is a word often misused synonymously with accounts receivable financing. Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of thereceivables, not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of an asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

9. Comparison between Conventional Bill Discounting and Factoring

10. Steps in Factoring

11. Buyer 7.Due date Payment Seller 1. Places Order 4.Transports goods 5.Assigns docs 2. App. Form 6.Prepayment 3.Buyer Approval GTF Domestic Factoring Process

12. Factoring Guidelines These guidelines are general in nature and each factoring organization need to adopt it with or without modification as the case may be depending on their specific work environment and work practice.

13. Factoring Guidelines Factoring Guidelines Policy Guidelines Procedural Guidelines Risk Mitigation Guidelines Pricing Guidelines

14. Policy Guidelines The policy guidelines suggested in this section covering all functional aspects of factoring are outlined as general principles to manage factoring business.

15. Policy Guidelines • 1. Factoring Guidelines: • Industry and business segment focus • Single client/ group limits • Single/ Group sales ledger limits of debtors • Discourage business types • Factoring facility parameters

16. Policy Guidelines • Factoring facility parameters : • Maximum outstanding amount • Individual debtor sales ledger limit • Debtor wise prepayment percentage • Debtor wise facility pricing • Upfront fee • Penal interest for delayed payment • Covenants • Security

17. Policy Guidelines • 2. Credit Assessment: • Assessment of performance risk of client (Seller) • Assessment of financial health and payment record of debtor • Assessment of trade reputation and financial health of client (for eventual recourse, if required)

18. Policy Guidelines 3. Organization structure & Segregation of duties MD/ CEO Head of Factoring Relationship/ Marketing Mgt Credit & Risk Management Credit Admin. Management Internal Audit

19. Policy Guidelines • 3. Segregation of duties (page 91-92): • Relationship/ Marketing Management • Credit & Risk Management • Credit Administration Management

20. Policy Guidelines 4. Approval Authority. 5. Internal Audit

21. Procedural Guidelines • Credit Evaluation: • Performance risk of client (Seller) • Credit and Payment Risk or Debtor (buyer) • Credit Risk of Client (seller) in the eventuality of recourse

22. Procedural Guidelines • Performance Risk: • Years of relationship between buyer & seller • All instance of delayed supply and delayed payment • In case of dilutions, the extent and reason for dilution • Defaults of any nature • Check whether there is two way trade between buyer & seller

23. Procedural Guidelines • Credit & Payment Risk of Debtor: • Industry Competency - Quality of Management & Experience - Competitive position in the market - Types of industry • Transparency & References • Financial Assessment • Debtor Payment Practice

24. Procedural Guidelines • Credit Risk of Client (seller): • Non payment of debtor • Trade dispute • Deterioration of financial health The factor could design an Application Form for its clients which will enable the factor to capture in one shot all required information for risk analysis and processing. (sample form : page 104-107, Appendix iii)

25. Procedural Guidelines 2. Approval Process 3. Credit Documentation - Account Receivables Mgt Agreement - Introductory letter from debtor - Special Undertakings, if any - Demand Promissory Notes - Notarized Power of Attorney in Favor of Factor - Post Dated Cheques - Personal Guarantee (s) 3. Credit Administration 4. Sales Ledger Administration

26. Risk Analysis & Mitigation • Two Primary Risks: • Performance risk of client (seller) • Credit & Payment risk of debtor (buyer) Risk Mitigation Method Includes: Proper evaluation of invoice Evaluation of financial statements of debtor Trade inquiries Appropriate 7 enforceable documents Special conditions: Whole turnover clause, set off clause etc. Effective online credit monitoring Legal actions

27. Pricing Guidelines • Pricing for factoring facility is generally structured in two parts: • Returned on fund employed – discount charge. • Charge for service provided – factoring charge.

28. THANK YOU.