What is Factoring
• Factoring is a financial transaction whereby a
business sells its accounts receivable (i.e.,
invoices) to a third party (called a factor) at a
discount in exchange for immediate money
with which to finance continued business.
Factoring differs from a bank loan in
three main ways.
• First, the emphasis is on the value of the
receivables (essentially a financial asset), not
the firm’s credit worthiness.
• Secondly, factoring is not a loan – it is the
purchase of a financial asset (the receivable).
• Finally, a bank loan involves two parties
whereas factoring involves three.
• The three parties directly involved are: the one
who sells the receivable, the debtor, and the
• The receivable is essentially a financial asset
associated with the debtor’s liability to pay
money owed to the seller (usually for work
performed or goods sold).
• The seller then sells one or more of its invoices
(the receivables) at a discount to the third party,
the specialized financial organization (the factor),
to obtain cash.
• The sale of the receivables essentially transfers
ownership of the receivables to the factor,
indicating the factor obtains all of the rights and
risks associated with the receivables.
• Accordingly, the factor obtains the right to
receive the payments made by the debtor for the
invoice amount and must bear the loss if the
debtor does not pay the invoice amount.
• Usually, the account debtor is notified of the sale
of the receivable, and the factor bills the debtor
and makes all collections.
• In factoring, a financial institution (factor) buys
the accounts receivable of a company (Client)
and pays up to 80%(rarely up to 90%) of the
amount immediately on agreement.
• Factoring company pays the remaining amount
(Balance 20%-finance cost-operating cost) to the
client when the customer pays the debt.
• Collection of debt from the customer is done
either by the factor or the client depending upon
the type of factoring.
• RBI issued guidelines for factoring services in
• The first factoring company SBI Factors and
Commercial Ltd. Started operation in April,
Factoring companies in India
• Canbank Factors Limited: http://www.canbankfactors.com
• SBI Factors and Commercial Services Pvt. Ltd: http://www.sbifactors.com
• The Hongkong and Shanghai Banking Corporation Ltd: http://www.hsbc.co.in/1/2/corporate/trade-and-
• Foremost Factors Limited: http://www.foremostfactors.net
• Global Trade Finance Limited: http://www.gtfindia.com
• Export Credit Guarantee Corporation of India Ltd:
• Citibank NA, India: http://www.citibank.co.in
• Small Industries Development Bank of India (SIDBI): http://www.sidbi.in/fac.asp
• Standard Chartered Bank: www.standardchartered.co.in
• A major advantage of Factoring is that it is a
form of off balance sheet financing.
• In trade finance, forfaiting involves the
purchasing of receivables from exporters.
• The forfaiter will take on all the risks involved
with the receivables.
• It is different from the factoring operation in the
sense that forfaiting is a transaction based
operation while factoring is a firm based
• meaning, in factoring, a firm sells all its
receivables while in forfaiting, the firm sells one
of its transactions.
• Benefits for using forfaiting include
eliminating risks (political, transfer and
commercial risks) and improving cashflows.
Increases cash flow.
• Forfaiting converts a credit-based transaction
in to a cash transaction.
• Forfeiting is without recourse to the seller.
• The purchase is in the form of discounting the
documents covering the entire risk of non
payment in collection.
• Under a recourse factoring arrangement,
factor has recourse to the client if the
receivables factored turns out to be
• Factor does not assume credit risks associated
with the receivables.
Non Recourse Factoring
• Under a non recourse factoring arrangement,
factor does not have recourse to the client if
the receivables factored turns out to be
• The loss arising out of the irrecoverable
receivables is borne by him, as a
compensation for which he charges a higher
Legal Aspects of Factoring
• There is no codified legal framework for
factoring in India.
• Regulated under the law of Contract.
• Legal relationship largely determined by the
terms of the contract.
Factoring versus Bill Discounting
• Bill discounting is always with recourse while
factoring can be either with recourse or
• Bill Discounting does not involve assignment
of debt as is the case with factoring.
• Bill discounting is a fund based service
provided by finance companies.
• An endorsed bill of exchange is handed over
for ready money.
• The margin between the ready money and the
face value of the bill is called ‘ Discounting of
Bill of exchange
• Suppose a seller sells goods or merchandise to
• In most cases, the buyer would like to
purchase on credit.
• The seller draws a Bill of exchange of a given
maturity on the buyer.
• The seller has now assumed the role of a
creditor and is called the drawer of the Bill.
• The buyer who is the debtor, is called the
• The seller then sends the bill to the buyer who
acknowledges it by writing his acceptance on
• In order to prevent misuse, the RBI placed
several restrictions on the bill discounting
• As a result, Bill discounting has substantially
declined in importance.
Questions for Revision
• What is factoring ? How is it different from
– A Bank Loan
– Bill Discounting