A process that Accounts from Time preferences.
Converts Future Values to Present Values.
DEFINITION OF DISCOUNTING
The process of converting values expressed in dollars received at a
point in time to an equivalent value expresses in dollars received at an
earlier point in time.
Compounding is the reverse process.
While discounting a bill, the Bank buys the bill (i.e. Bill of Exchange or
Promissory Note) before it is due and credits the value of the bill after
a discount charge to the customer's account.
The transaction is practically an advance against the security of the
bill and the discount represents the interest on the advance from the
date of purchase of the bill until it is due for payment.
A bill must be a usance bill.
It must have been accepted and bears at least two good signatures (e.g. of
reputable individuals, companies or banks etc.)
The Bank will normally only discount trade bills.
Where a usance bill is drawn at a fixed period after sight the bill must be
accepted to establish the maturity.
The discount should be based on real trade background.
The discount tenor starts from the date of discount and expires at the
maturity of the bill.
DIFFERENT TYPES OF
Sales bill discounting (Drawer bill discounting).
Supplier bill discounting (Drawee bill discounting).
LC Bill discounting.
INVOICE DISCOUNTING – CASE STUDY
I have owned and operated a proﬁtable business for the past 10
years manufacturing and supplying Prescription lenses and frames to
opticians throughout the UK.
During the so called credit crunch, I was annoyed and frustrated by
my bank trying continually to Scale back the limit on my business
overdraft without any valid reason given.
For example, the Account limit in 2007 was £150,000 but this year I
was advised that it had been arbitrarily reduced To £100,000 which
immediately put a stop to my new product development and
My Accountants, who are a large national ﬁrm, directed me to Murray
& Co in London who suggested That the overdraft could be
substituted by an Invoice Discounting facility.
At ﬁrst I was not convinced Of the beneﬁts but now after a few months
they are very clear.
I am able to borrow up to 90% of my outstanding invoices at any time
which allows me access of up to £250,000 in working capital.
This limit will be extended and increased in line with my business
Expansion plans which are progressing well.
Not only did invoice discounting generated more capital
But also by switching Lenders my own bank had no choice but to
release a second charge on my
House because the overdraft no longer existed.
Obviously, that gave my wife and I the comfort of
Knowing that our home was safe in the event of any future ﬁnancial
In fact, the only Security held by my new funder is the value of the
JB – Northwest
Came into existence in the year 1920
It was not an organised sector that time
Association of British Factors(ABF) came in 1976
Nearly 90% of global factoring turnover comes from USA & European
RBI appointed the C.S.Kalyanasundaram Committee (1988)
It suggested to start factoring by a bank through its subsidiary
DEFINITION OF FACTORING
Robert W. Johnson in his book ‘Financial Management’ states,
“factoring is a services involving the purchase by a financial
organisation, called a factor, of receivables owned to manufacturers
and distributors by their customers, with the factor assuming full credit
and collection responsibilities.
WHAT IS FACTORING?
Factoring is an ongoing arrangement between the client and the
factor, where the sales of goods and services are made on open
account terms and the invoices for the same are assigned to the factor
regularly for the purpose of funding, collection and sales ledger
Factoring involves a long-term relationship between the buyer and the
seller with the whole turnover being assigned to the factoring
WHY USE FACTORING?
Through the use of Factoring receivables are instantly converted into
cash leading to improved cash flows that can help funding of future
It facilitate an efficient follow up of payments from buyers, which is
made possible through relationships developed by factors with client’s
Factoring provides credit protection for export sales which enables to
do business with buyers who are unwilling to open Letters of Credit.
Factoring also provides other peripheral services such as advisory
services, credit assessment, etc.
WHAT ARE THE TYPES OF FACTORING
There are basically two types of Factoring arrangements:
1) Domestic Factoring- If you are selling in India.
2) International Export Factoring- If you are exporting from India.
The factoring arrangement where all the three- the factor, the seller
and the buyer are in the same country, subject to the same laws.
The factoring arrangement, where the seller and the buyer are in two
different countries involving co-operation between two factoring
companies, one in the seller’s country (Export Factor) and the other in
the buyer’s country (Import Factor)
SERVICES OFFERED BY FACTOR
Follow-up and collection of Receivables from Clients.
Purchase of Receivables with or without recourse.
Help in getting information and credit line on customers (credit
Sorting out disputes, if any, due to his relationship with Buyer &
PROCESS INVOLVED IN FACTORING
Client concludes a credit sale with a customer.
Client sells the customer’s account to the Factor and notifies the
Factor makes part payment (advance) against account purchased,
after adjusting for commission and interest on the advance.
Factor maintains the customer’s account and follows up for payment.
Customer remits the amount due to the Factor.
Factor makes the final payment to the Client when the account is
collected or on the guaranteed payment date.
MECHANICS OF FACTORING
The Client (Seller) sells goods to the buyer and prepares invoice with
a notation that debt due on account of this invoice is assigned to and
must be paid to the Factor (Financial Intermediary).
The Client (Seller) submits invoice copy only with Delivery Challan
showing receipt of goods by buyer, to the Factor.
The Factor, after scrutiny of these papers, allows payment (,usually
upto 80% of invoice value). The balance is retained as Retention
Money (Margin Money). This is also called Factor Reserve.
The drawing limit is adjusted on a continuous basis after taking into
account the collection of Factored Debts.
Once the invoice is honoured by the buyer on due date, the
Retention Money credited to the Client’s Account.
Till the payment of bills, the Factor follows up the payment and sends
regular statements to the Client.
CHARGES FOR FACTORING SERVICES
Factor charges Commission (as a flat percentage of value of Debts
purchased) (0.50% to 1.50%).
Commission is collected up-front.
For making immediate part payment, interest charged. Interest is
higher than rate of interest charged on Working Capital Finance by
If interest is charged up-front, it is called discount.
Up to 75% to 85% of the Invoice Receivable is factored.
Interest is charged from the date of advance to the date of collection.
Factor purchases Receivables on the condition that loss arising on
account of non-recovery will be borne by the Client.
Credit Risk is with the Client.
Factor does not participate in the credit sanction process.
In India, factoring is done with recourse.
NON RECOURSE FACTORING
Factor purchases Receivables on the condition that the Factor has no
recourse to the Client, if the debt turns out to be non-recoverable.
Credit risk is with the Factor.
Higher commission is charged.
Factor participates in credit sanction process and approves credit limit
given by the Client to the Customer.
In USA/UK, factoring is commonly done without recourse.
Factor does not make any advance payment to the Client.
Pays on guaranteed payment date or on collection of Receivables.
Guaranteed payment date is usually fixed taking into account previous
collection experience of the Client.
Nominal Commission is charged.
No risk to Factor.
CROSS BRODER FACTORING
It is similar to domestic factoring except that there are four parties,
b) Export Factor,
c) Import Factor, and
It is also called two-factor system of factoring.
Exporter (Client) enters into factoring arrangement with Export Factor
in his country and assigns to him export receivables.
Export Factor enters into arrangement with Import Factor and has
arrangement for credit evaluation & collection of payment for an
Notation is made on the invoice that importer has to make payment to
the Import Factor.
Import Factor collects payment and remits to Export Factor who
passes on the proceeds to the Exporter after adjusting his advance, if
Where foreign currency is involved, Factor covers exchange risk also.
STATUTES APPLICABLE TO
Factoring transactions in India are governed by the following Acts:-
Indian Contract Act
Sale of Goods Act
Transfer of Property Act
Banking Regulation Act.
Foreign Exchange Regulation Act.
WHY FACTORING HAS NOT BECOMING
POPULAR IN INDIA
Banks’ reluctance to provide factoring services.
Bank’s resistance to issue Letter of Disclaimer (Letter of Disclaimer is
mandatory as per RBI Guidelines).
Problems in recovery.
Factoring requires assignment of debt which attracts Stamp Duty.
Cost of transaction becomes high.
TURKISH RUGS MANUFACTURERS PREFER
INTERNATIONAL FACTORING – CASE STUDY
Thanks to factoring, Step Carpet could grow their Exports
Step Halıcılık ve Mağazacılık San ve Tic A.S. is a well-known brand
of contemporary rugs with boutiques in London, Paris, Milan, Istanbul,
New York, Dubai and many other design capitals of the world.
Step Carpet focuses on the design and manufacturing of modern,
fashionable rugs and home accessories. Combining traditional rugmaking techniques with new technology.
Step is known as a pioneer in the interior design business with
innovative collections inspired by the latest fashion, colors and
Step Carpet’s strategy is to expand their business to further European
markets. TEB Factoring as Export Factor was recommended and
introduced by one of their clients, an A.S, to Step Carpet, which
shares the production facility with them.
New debtors from Germany and the Czech Republic were requiring
longer open account terms in place of L/C’s. After a positive
assessment, TEB Factoring was able to offer a full notification export
factoring facility to Step Carpet.
In 2012, Step Carpet decided to sign an export factoring agreement
with TEB to utilize their international factoring services, which includes
the following benefits:
1. 100 % credit protection against customer insolvency default backed
by FCI Import Factors.
2. Outsourcing of the receivables ledger bookkeeping workload and
local collection services provided by Import Factors abroad.
3. Short-term advances against the factored accounts receivable
provided by TEB Factoring.
Since then, thanks to the excellent service provided by TEB Factoring
and its Import Factor correspondents, Euro factor AG in Germany and
Factoring KB in the Czech Republic, Step Carpet has successfully
exploited new markets, increased their export business, and solidified
their supplier relationships. For Step, international factoring has been
a useful financial tool which will enable them to generate an additional
projected turnover of EUR10 million in 2013.
“Forfait” is derived from French word ‘A Forfait’ which means
surrender of fights.
Forfaiting is a mechanism by which the right for export receivables of
an exporter (Client) is purchased by a Financial Intermediary
(Forfaiter) without recourse to him.
It is different from International Factoring in as much as it deals with
receivables relating to deferred payment exports, while Factoring
deals with short term receivables.
Exporter under Forfaiting surrenders his right for claiming payment for
services rendered or goods supplied to Importer in favor of Forfaiter.
Bank (Forfaiter) assumes default risk possessed by the Importer.
Credit Sale gets converted as Cash Sale.
Forfaiting is arrangement without recourse to the Exporter (seller)
Operated on fixed rate basis (discount)
Finance available up to 100% of value (unlike in Factoring)
Introduced in the country in 1992.
MECHNAICS OF FORFAITING
HELD TILL MATURITY
SELL TO GROUPS OF INVESTORS
TRADE IN SECONDARY MARKET
ESSENTIAL REQUISITES OF
Exporter to extend credit to Customers for periods above 6 months.
Exporter to raise Bill of Exchange covering deferred receivables from
6 months to 5 years.
Repayment of debts will have to be availed or guaranteed by another
Bank, unless the Exporter is a Government Agency or a Multi National
Co-acceptance acts as the yard stick for the Forfeiter to credit quality
and marketability of instruments accepted.
Promissory notes are sent for availing to the Importer’s Bank.
Availed notes are returned to the Importer.
Availed notes sent to Exporter.
Availed notes sold at a discount to a Forfaiter on a NONRECOURSE basis.
Exporter obtains finance.
Forfaiter holds the notes till maturity or securities these notes and
sells the Short Term Paper either to a group of investors or to
investors at large in the secondary market.
CHARACTERISTICS OF FORFAITING
Converts Deferred Payment Exports into cash transactions, providing
liquidity and cash flow to Exporter.
Absolves Exporter from Cross-border political or conversion risk
associated with Export Receivables.
Finance available upto 100% (as against 75-80% under conventional
credit) without recourse.
Acts as additional source of funding and hence does not have impact
on Exporter’s borrowing limits. It does not reflect as debt in Exporter’s
Provides Fixed Rate Finance and hence risk of interest rate fluctuation
does not arise.
Exporter is freed from credit administration.
Provides long term credit unlike other forms of bank credit.
Saves on cost as ECGC Cover is eliminated.
Simple Documentation as finance is available against bills.
Forfait financer is responsible for each of the Exporter’s trade
transactions. Hence, no need to commit all of his business or
significant part of business.
Forfait transactions are confidential.
COSTS INVOLVED IN FORFAITING
Commitment Fee:- Payable to Forfaiter by Exporter in consideration of
Commission:- Ranges from 0.5% to 1.5% per annum.
Discount Fee:- Discount rate based on LIBOR for the period
Documentation Fee:- Where elaborate legal formalities are involved.
Service Charges:- Payable to EXIM Bank.
WHY FORFAITING IS NOT DEVELOPED
Relatively new concept in India.
No ECGC Cover
High cost of funds
High minimum cost of transactions (USD 250,000/-)
RBI Guidelines are vague.
Very few institutions offer the services in India. EXIM Bank alone
Long term advances are not favoured by Banks as hedging becomes
Lack of awareness.
2. Extent of
Upto 75 – 80%
Service of Sale
With or Without
6. Charge Creation
NON AVAILABILITY FOR SHORT & LONG PERIODS.
NON AVAILABILITY FOR FINANCIALLY WEAK COUNTRIES.
DOMINANCE OF WESTERN CURRENCIES.
DIFFICULTY IN PROCURING INTERNATIONAL BANK’S
MECHANISM – A CASE STUDY OF
Export-Import Bank of India, (EXIM Bank) has started with a scheme to the
Indian exporters by working out an intermediary between the exporter and the
The scheme takes place in the following stages:
1. Negotiations being between exporter and importer with regard to contract price,
period of credit, rate of interest, etc.
2. Exporter approaches EXIM Bank with all the relevant details for an indicative
3. EXIM Bank approaches an overseas forfeiter, obtain the quote and gets back to
exporter with the offer.
MECHANISM- A CASE STUDY
4.Exporter and importer finalize the term of contract. All costs levied by a
forfeiter are to be transferred to the overseas buyer. As such discount and
other charges are loaded in the basic contract value.
5.Exporter approaches EXIM Bank and it in turn the forfeiter for the firm quote.
The exporter confirm the acceptance of the arrangement.
6.Export takes place — shipping documents along with bill of exchange,
promissory note have to be in the prescribed format.
MECHANISM- A CASE STUDY
7. Importer’s bank delivers shipping documents to importer against acceptance
of bill of exchange or on receipt of promissory note from the importer as the
case may be and send these to exporter’s bank with its guarantee.
8. Exporter’s bank gets bill of exchange/promissory note endorsed with the
words ‘Without Recourse’ from the exporter and present the document(s) to
EXIM Bank who in turn send it to the forfaiter.
MECHANISM- A CASE STUDY
9. Forfaiter discounts the documents at the pre-determined rate and passes on
funds to EXIM Bank for onward disbursement to exporter’s bank nostro account
of exporter’s bank.
10.Exporter’s bank credits the amount to the exporter.
11.Forfaiter presents the documents on due date to the importer’s bank and
receives the dues.
12.Exporter’s bank recovers the amount from the importer.