Factoring Solutions – As a Tool of Working Capital Finance

Looking for working capital finance?

Working capital is one of the main factors in the smooth functioning of any business. Without adequate working capital the business is squeezed, and in the long run its very existence comes under threat. This article explains factoring as a tool for meeting the working capital needs of a business.

What is factoring?

Factoring is a form of financial assistance obtained by discounting bills receivable. It is a transaction in which a business sells its accounts receivable — its invoices — to a third party called a factor, at a discount. There are three parties to the contract: the business, the customer, and the factor, which is normally a bank or financial institution.

What are the types of factoring?

There are mainly two: factoring of domestic receivables, known as domestic factoring, and factoring of export receivables, known as export factoring.

How does the arrangement work?

The business enters into a contractual arrangement with the factor to sell its debtors against a margin. The factor in turn realises payment from those debtors at the end of the credit period, recovers the sum due to it along with interest, and credits the balance to the bank account of the business.

What are the benefits?

• Instant realisation against invoices raised to customers
• Improved cash flow, which can allow the business to negotiate better pricing on purchases from its suppliers
• Financing that keeps pace with growth, without the periodic revisions to limits required under traditional working capital facilities such as overdraft or cash credit

In which currency can finance be obtained?

Domestic factoring facilities are necessarily in the home currency, which is the Indian Rupee for India. Export factoring facilities can be obtained either in Indian Rupees or in foreign currency, at the choice of the business.

What is the margin rate?

The margin generally ranges from 10% to 30%, based on parameters such as the nature of the business, the profile of its debtors, the profile of the business itself, and the bank or financial institution involved.

What is the interest rate?

For rupee facilities, the interest rate has historically been set against the lender’s Base Rate, typically Base Rate plus 2.50% to 7%. For foreign currency facilities it has been set against an interbank benchmark rate plus a spread. Benchmarks and spreads change over time, so confirm the current basis and the all-in rate with the lender. The rate is a function of credit analysis, taking in the nature of the business, the profile of its debtors, its own profile and track record, and the institution involved.

When should you consider factoring in foreign currency?

If your business is an export house and the receivables are in foreign currency, a foreign currency factoring arrangement may suit. In deciding between foreign currency and rupee facilities, exchange rate movements should be treated as a key determinant.

Does the bank require security?

Yes. Debtors or receivables are the primary security. Normally the factor does not require collateral, but at times it may insist on collateral ranging from 50% to 100% of the facility sought, depending on the case.

Are there processing fees?

Yes. The factor normally charges a processing or setup fee of around 1% of the facility sought.

Are there other service charges?

Yes. The factor charges a service charge for collecting invoices from customers on behalf of the business, normally a percentage of invoice value. Some factors also offer a credit protection facility, for which an additional charge applies as a percentage of invoice value.

What are the eligibility criteria?

These depend on the factor, but normally include:

• At least three years’ profitable track record
• Positive tangible net worth, above a specified minimum that varies by institution
• A specified minimum turnover, which also varies by institution

What documents are required?

• Copy of identity proof
• Copy of address proof
• Copy of constitution documents, such as the partnership deed, memorandum and articles of association, or certificate of registration or incorporation
• Copies of applicable government registrations, such as PAN, IEC, and indirect tax registrations
• Copies of indirect tax returns
• List of directors with identity and address proofs and proof of their appointment
• Copy of the board resolution
• Copies of financial statements, audited where applicable
• Net worth statements of promoter directors
• Financial projections
• Details of existing and projected sales by customer
• List of customers with their profiles

Steps to avail a domestic factoring facility

• The factor undertakes a field survey of the sales ledgers of the business
• Credit assessment of the business
• Setting of credit limits for each customer
• Signing of the factoring agreement
• The customers agree to route all payments through the factor
• After delivery of goods, the business forwards copies of invoices and supporting documents to the factor
• The business can draw prepayments up to the agreed limit

Steps to avail an export factoring facility

• The factor undertakes a field survey of the sales ledgers of the business
• Credit assessment of the business
• Setting of credit limits for each overseas customer
• Signing of the factoring agreement
• After shipping the goods, the business forwards copies of invoices and supporting documents to the factor
• The business can draw prepayments up to the agreed limit
• Under the supervision of the factor, an overseas partner collects and transfers payments to it
• The factor credits your account, less prepayments and charges

If you would like help assessing whether factoring suits your working capital position, contact us at cs@bkcprohub.com.