Looking for Working Capital Finance?
Use Factoring Solutions to leverage your cost of working capital!
Working Capital is one of the main factors leading to smooth functioning of any business. In absence of adequate working capital funds, the business gets suffocated and in the long run the very existence of the business comes at stake. The present article explains “Factoring Solutions” as a tool of meeting working capital needs of any business.
What is Factoring Solutions?
Factoring is a form of financial assistance which is obtained on discounting of bills receivable. It is a financial transaction in which a business sells its accounts receivable, i.e., invoices to a third party called a factor at a discount. There are three parties to the contract. (a) Business, (b) Customer and (c) Factor which is normally a bank or financial institution giving factoring solutions to business.
What are the types of Factoring Solutions?
There are mainly two types of factoring solutions, (a) Factoring Solutions for Domestic Receivables, known as Domestic Factoring Solutions and (b) Factoring Solutions for Export Receivables, known as Export Factoring Solutions.
How the arrangement works?
The business enters into a contractual arrangement with third party (known as Factor), normally banks or financial institutions, to sell his debtors (accounts receivables) against a margin, wherein the bank or the financial institution in turn realizes the payment from such debtors at the end of the credit period, recovers the sum of money due to them along with interest and credits the balance amount in the bank account of the business. Graphically, factoring solutions could be explained with the following figure;
What are the benefits of Factoring Solutions?
A business can get the following benefits;
- Instant realization towards invoices raised to Customer
- Optimize Cash flow which would enable business to negotiate competitive pricing on purchase of goods from its supplier
- Financing would keep up with the growth in the business, the business does not need to go for revisions in working capital finance which is required in case of traditional methods of working capital finance like over draft or cash credit facilities
In which currency Finance could be obtained?
Domestic Factoring facilities are necessarily in the home currency, which is Indian Rupee for India. Export factoring facilities could be obtained either in Indian Rupee or in foreign currency at the choice of the business.
What is the margin rate?
The margin ranges from 10% to 30% based on parameters like nature of business, profile of debtors, profile of business and bank or financial institution involved.
What is the interest rate?
In the case of Factoring Solutions in Indian Rupee, the interest rate is based on Base Rate (BR) and is normally BR + 2.50% to BR + 7% which could work out to around 12.50% to 17%. Interest rate in Factoring Solutions in foreign currency is based on London Interbank Offered Rate (LIBOR) and is normally LIBOR + 0.50% to LIBOR + 3% which could work out to around 3% to 6%. The rate of interest is the function of credit analysis based on factors including nature of business, profile of debtors, profile and track record of business and bank or financial institution involved.
When to go for Factoring Solutions in Foreign Currency?
If your business is an export house and the debtors / receivables are in foreign currency, the business could go for foreign currency factoring arrangement, however, while taking the strategic decision on which whether to avail factoring facility in foreign currency or in Indian Rupee, the exchange rate fluctuations should be considered as a key determinant factor.
Does bank require Security?
Yes, the banks require securities. Debtors or Receivables are the primary security. Normally, the factoring bank or institution does not require collateral securities. However, at times the factoring banks or financial institutions may also insist on collateral securities which may range from 50% to 100% of the factoring arrangement sought depending on case to case basis.
Does Factoring Bank or Institution charge any processing fees?
Yes, the factoring bank or institution charges professing or a setup fee which is normally around 1% of the factoring facilities sought for.
Does Factoring Bank or Institution charge any other service charge?
Yes, the factoring bank or institution charges service charge for collection services of invoices from customers on behalf of business which is normally certain percentage of invoice value. The factoring bank or institution selectively also offer “Credit Protection” facility for which additional service charges at a certain percentage of invoice value is collected from the business.
What are the eligibility criteria?
The eligibility criteria depend on the factoring bank or institution, however, normally any factoring bank or institution would require following criteria;
- At least 3 years’ profitable track record
- Positive tangible Net Worth with specified minimum net worth size which varies by bank or institution
- Specified minimum turnover which varies by bank or institution
What are the documents required to avail the factoring facility?
Documents include;
- Copy of identity proof
- Copy of address proof
- Copy of Constitution document like partnership deed, memorandum & articles of association, certificate of registration or incorporation
- Copies of various government registrations like VAT, Service Tax, PAN Card, IEC, Excise, Customs, etc.
- Copies of VAT / Service Tax Returns
- List of directors with their identity and address proofs and the proof of their appointment as directors in the Company
- Copy of board resolution
- Copies of financial statements, audited when applicable
- Net Worth statements of Promoter Directors
- Financial Projections
- Details of existing and projected sales by Customer
- List of Customers with their profile
What are steps to avail Domestic Factoring facility?
Banks or financial institutions involved normally take the following steps;
- The factoring bank or institution undertakes field survey of sales ledgers of the business
- Credit assessment of the business
- Setting of Credit limits for each of the customers of the business
- Signing of factoring agreement between the business and the factoring bank or institution
- The customers of the business accept to route all payments through the factoring bank or institution
- Post delivery of goods, the business needs to forward copies of invoices and supporting documents to the factoring bank or institution
- The business can draw prepayments up to the agreed limit
What are steps to avail Export Factoring facility?
Banks or financial institutions involved normally take the following steps;
- The factoring bank or institution undertakes field survey of sales ledgers of the business
- Credit assessment of the business
- Setting of Credit limits for each of the overseas customers of the business
- Signing of factoring agreement between the business and the factoring bank or institution
- Post shipping of your goods, the business needs to forward copies of invoices and supporting documents to the factoring bank or institution
- The business can draw prepayments up to the agreed limit
- Under the supervision of the factoring bank or institution, an overseas factor partner collects and transfers payments to the factoring bank or institution
- The factoring bank or institution credits your account, less prepayments and/or charges
