Introduction
· The word Factor is derived from Latin “Facere” meaning “to get things done”.
The word factor comes from the Latin word facere, which means "to make or to do". A factor was originally an agent, or "doer," who carried out business for another person. The sense of "to get things done" is an expansion of this original meaning.
· Factoring is an arrangement between a factor (financial institution) and a business concern where the factor collects debts and receivables on behalf of the business and provides payment after deducting a commission.
· It helps firms meet working capital requirements by selling their receivables.
Definition of Factoring
1. Peter M. Biscose:
Factoring is a continuing legal relationship between a factor and a client where the factor purchases the client’s book debts with or without recourse, controls credit, and administers sales ledger.
2. C.S. Kalyanasundaram Report (RBI):
Factoring is an arrangement where a financing institution assumes credit and collection functions, purchases receivables, maintains ledger, and performs auxiliary functions.
Factoring = sale or collection of book debts by factor for commission.
Characteristics
· Agreement between financial institution and business.
· Selling receivables (book debts) to a factor.
· Factor charges commission (5%–20%).
· Normally 90–150 days.
· With or without recourse.
Factoring can be of two types:
· With recourse: If the customer fails to pay, the business must repay the factor.
· Without recourse: If the customer defaults, the factor bears the loss.
So, the risk of non-payment depends on the type of agreement
· Off-balance sheet financing.
Factoring does not appear as a loan or liability on the company’s balance sheet because receivables are sold, not borrowed against. Hence, it is called off-balance sheet financing — it improves liquidity without increasing debt
· Not possible for bad debts.
Factoring is done only for genuine and collectible receivables.
If debts are already bad (customers unlikely to pay), factors will not accept them because the purpose of factoring is to finance recoverable amounts, not write-offs.
Modus Operandi (Process)
The "modus operandi" or process in financial factoring involves a client selling their accounts receivable to a factor in exchange for immediate cash. The process includes establishing an agreement, the client invoicing their buyer, assigning these invoices to the factor, and the factor providing a percentage of the invoice value upfront. After collection, the factor pays the balance to the client after deducting their fees.
Step-by-Step Factoring Process:
1. Agreement:
The client and the factor enter into a factoring agreement, outlining terms, credit limits, and services.
2. Invoicing:
The client continues to supply goods or services to their customers (buyers) and generates invoices as usual.
3. Assignment of Debts:
The client hands over these invoices to the factor, along with documentation like delivery challans.
4. Notification to Buyers:
Buyers are informed that their debt has been assigned to the factor and are instructed to make payments directly to the factor.
5. Advance Payment:
The factor provides an advance payment, typically a percentage (e.g., 80%), of the invoice value to the client.
6. Collection:
The factor then collects the full amount from the buyer.
7. Balance Payment:
Once the debt is realized, the factor pays the remaining balance to the client, minus fees and interest.
8. Record Keeping:
The factor provides the client with a monthly account statement detailing commissions, interest, and the client's overall financial standing with the factor.
Parties:
1. Firm (Seller)
The business organization that sells goods or services on credit to customers.
It enters into a factoring agreement to get immediate cash for its credit sales
2. Debtor (Buyer)
The customer who buys goods or services from the firm on credit and is liable to pay the amount due
3. Factor
A specialized financial company or bank that purchases the receivables from the firm, provides advance cash, and collects payment from the debtors
Steps:
A. Firm gets credit order from customer.
The firm (seller) receives an order from the customer (debtor) to purchase goods or services on credit. This means the customer will pay after a specified credit period, not immediately.
B. Sends goods/invoice to customer.
The firm dispatches the goods or provides the services to the customer.
It also sends an invoice mentioning the amount due and payment date.
This invoice acts as proof of sale and credit due
C. Sends invoice to factor.
The firm then sends a copy of the invoice and other relevant documents (like proof of dispatch) to the factor. This step assigns the receivable (right to collect payment) to the factor.
D. Factor pays advance (80–90%).
After verifying the invoice, the factor provides an advance payment to the firm — generally 80–90% of the invoice value. This gives the firm immediate working capital without waiting for the debtor’s payment
E. Factor collects from debtor.
The factor takes responsibility for collecting the payment from the debtor on the due date. The firm no longer has to follow up with customers for payment.
F. Debtor pays factor.
On the due date, the debtor pays the invoice amount directly to the factor, as instructed earlier
G. Factor remits balance to firm.
After receiving the full payment from the debtor, the factor deducts commission and service charges, and then pays the remaining balance (10–20%) to the firm
The firm sells goods on credit → sends invoice to factor → factor gives advance → collects from debtor → remits remaining balance after deduction.
Factor maintains sales ledger and sends periodic reports.
Types of Factoring
1. Domestic Factoring
This type of factoring is used within the same country — all parties (firm, debtor, and factor) are domestic.
It includes three forms:
a. Disclosed Factoring
· The customer (debtor) is informed about the factoring arrangement.
· The invoice clearly mentions that payment should be made to the factor.
Types:
· Recourse Factoring –
The client (seller) is liable if the debtor fails to pay. The factor can recover the unpaid amount from the client.
· Non-Recourse Factoring –
The factor bears the risk of non-payment. The client is not responsible for bad debts.
b. Undisclosed Factoring
· The customer is not informed about the factoring arrangement.
· The factor collects payment in the name of the firm.
· This type is useful when the seller wants to keep the arrangement confidential.
c. Invoice Discounting
· The factor provides finance by discounting the invoices/bills.
· The rate of discount is based on current market conditions.
· The firm continues to collect payments from customers, but gets immediate cash from the factor.
2. Export Factoring
· Used in international trade.
· The factor, located in the exporter’s country, collects export proceeds from the foreign buyer.
· Helps exporters manage credit risk, currency risk, and ensures timely collection.
3. Full Service Factoring
· Also known as without recourse factoring.
· Provides all services such as:
o Financing
o Ledger maintenance
o Collection of debts
o Credit protection
o Advisory services
· Offers protection against bad debts.
4. Maturity Factoring
· The factor does not provide advance payment.
· The full amount is paid to the client only on the guaranteed payment date or when debtor pays.
· Other services like ledger management and collection are provided.
5. Advance Factoring
· The factor pays an advance (around 70%–80%) of the invoice value immediately.
· The remaining balance is paid after the debtor settles the invoice, less charges and interest.
· Useful for firms needing quick liquidity.
6. Agency Discounting
· The factor only provides finance and bad debt protection.
· Other services like ledger maintenance and collection are not offered.
· The firm continues to manage collections.
7. Bank Participation Factoring
· The factor arranges funds from a bank to advance money to the client.
· The factor pays interest to the bank for borrowed funds.
· Useful for large transactions where additional funding is needed
Types of Factoring
1. Domestic Factoring
a. Disclosed – Customer informed.
o Recourse: Client liable if debtor fails to pay.
o Non-recourse: Factor bears loss.
b. Undisclosed – Customer not informed.
c. Invoice Discounting – Finance provided against bills.
2. Export Factoring – Factor collects export proceeds on behalf of exporter.
3. Full Service Factoring – All services + bad debt protection.
4. Maturity Factoring – Payment made only at due date.
5. Advance Factoring – Factor pays 70–80% upfront.
6. Agency Discounting – Only financing and bad debt protection.
7. Bank Participation Factoring – Factor arranges advance from bank.
Functions of a Factor
A factor performs several important functions to help a business manage its receivables, improve cash flow, and reduce credit risk. The major functions are as follows:
1. Maintenance of Sales Ledger
· The factor maintains a detailed sales ledger (record of all credit sales and payments).
· Prepares and updates payment schedules for each debtor.
· Sends periodic reports to the client showing the status of outstanding receivables.
· Helps the firm monitor its credit position and plan future business activities.
Benefit: Reduces the firm’s administrative workload and improves record accuracy.
2. Collection Facility
· The factor undertakes the responsibility of collecting payments from the firm’s customers (debtors).
· Uses professional collection methods and timely reminders to ensure prompt payment.
· May initiate legal action if customers delay or default.
· Saves the firm time, effort, and manpower costs involved in collection.
Benefit: The firm can focus on its core business instead of debt collection.
3. Financing Trade Debts
· The factor provides immediate cash to the firm by advancing up to 80% of the invoice value.
· The remaining balance (20%) is paid after collection from the debtor, after deducting charges.
· This helps the firm maintain working capital and meet short-term obligations.
Benefit: Improves cash flow and reduces dependence on bank loans.
4. Credit Control
· The factor conducts a thorough analysis of the customers’ creditworthiness before approving credit sales.
· Uses the 3 C’s:
o Character – Integrity of the debtor.
o Capacity – Ability to repay.
o Creditworthiness – Past payment record.
· Sets credit limits for each customer to reduce risk of bad debts.
Benefit: Helps the firm avoid selling to risky customers and ensures safer credit policies.
5. Advisory Services
· The factor provides expert advice on:
o Market trends and changes in customer behavior.
o Financial management and credit policies.
o Related financial services like leasing, hire purchase, and merchant banking.
· Assists the firm in improving invoicing procedures and accounts receivable management.
Benefit: Helps the firm make informed decisions and improve overall financial efficiency
Functions of a Factor
· Maintenance of Sales Ledger – Payment schedule, reports.
· Collection Facility – Professional collection, cost saving.
· Financing Trade Debts – Up to 80% advance.
· Credit Control – Fixing credit limits, analyzing 3C’s.
· Advisory Services – Market trends, client advice.
Factoring in India
Factoring services in India were introduced as a result of recommendations made by the Kalyanasundaram Committee (1989), appointed by the Reserve Bank of India (RBI) to study the feasibility and structure of factoring operations in the country.
1. Kalyanasundaram Committee (1989)
· In 1989, the RBI set up a Study Group under C.S. Kalyanasundaram to examine the need for and scope of factoring services in India.
· The committee observed that many small and medium enterprises (SMEs) faced delays in collecting receivables and shortages of working capital.
· It recommended introducing factoring services to bridge this gap and complement traditional bank financing.
2. Establishment of SBI Factors & Commercial Services Ltd. (1991)
· Following the committee’s report, SBI Factors and Commercial Services Ltd. (SBI FACS) was established in 1991 as India’s first factoring company.
· It was promoted by the State Bank of India to provide specialized factoring services to Indian businesses, especially SMEs.
3. RBI Guidelines
· The RBI issued guidelines for the operation of factoring companies based on the committee’s recommendations.
· These guidelines covered:
o Scope of factoring services (domestic and export)
o Pricing structure (finance cost + service charges)
o Eligibility criteria for factoring institutions
o Risk management and credit assessment
o Encouragement for bank subsidiaries to handle factoring business
Key Recommendations of the Committee:
· Factoring services should complement banking services.
· Export factoring should be introduced to support exporters.
· Pricing of factoring should include:
o Finance cost ≈ 16% per annum
o Service charge ≈ 2.5–3% of invoice value
· Factoring organizations should use computerized systems for efficiency.
· Linkages between banks and factoring companies should be established.
· Small Scale Industries (SSI) should be given special attention
Factoring in India
· Based on Kalyanasundaram Committee (1989).
· SBI Factors & Commercial Ltd. established in 1991.
· RBI issued guidelines.
Key Recommendations:
· Scope for factoring services.
· Export factoring facility.
· Pricing: Finance @16%, Service @2.5–3%.
· Bank subsidiaries to handle factoring.
· Use of computers and credit agencies.
· Focus on SSI units.
Benefits
1. Improves Cash Flow – No new debt, meets tax/work capital.
2. Improves Credit Services – Reduces bad debt, better admin.
3. Flexibility – Any volume of receivables.
Factoring vs Bills Discounting
Aspect | Factoring | Bills Discounting |
Nature | Sale of all receivables | Single transaction |
Notification | One-time | Each bill |
Charges | Commission | Discount margin |
Documents | Copies | Originals required |
Recourse | With/Without | Always with recourse |
Forfaiting
The term “Forfaiting” is derived from the French word “Forfait”, which means “to surrender” or “give up one’s rights”. In forfaiting, the exporter surrenders the right to receive payment from the importer to a forfeiter (a financial institution or bank) in exchange for immediate cash.
· From French “Forfait” = to surrender.
· Export receivables discounted without recourse for medium/long term (up to 5 years).
· Used in international trade (capital goods, commodities).
Key Features
· It involves discounting export receivables (such as promissory notes or bills of exchange) without recourse, i.e., the forfeiter bears all risks (credit risk, political risk, and currency risk).
· It is used for medium to long-term credit transactions — typically 180 days to 5 years.
· Mainly used in international trade, especially for the export of:
o Capital goods
o Machinery
o Large commodities
o Infrastructure projects
Purpose
· To provide immediate cash flow to the exporter.
· To eliminate the risk of non-payment by the importer.
· To make exports more competitive by offering credit terms to foreign buyers.
In forfaiting, an exporter sells their long-term receivables (credit sales) to a forfeiter at a discount and receives immediate payment.
The forfeiter collects the payment from the importer later and bears all risks
Parties Involved in Forfaiting
In a forfaiting transaction, there are four main parties, each playing a specific role in facilitating the export financing process:
1. Exporter (Seller / Beneficiary)
· The seller of goods or services in the exporting country.
· Sells goods to the importer on credit terms.
· Transfers (surrenders) the receivables (amounts due) to the forfeiter in exchange for immediate cash payment.
· Benefits by receiving 100% payment upfront and avoiding credit and political risks.
2. Importer (Buyer)
· The purchaser of goods or services located in the importing country.
· Agrees to pay over a deferred credit period (usually medium to long term).
· Issues promissory notes or bills of exchange in favor of the exporter as a promise to pay in the future.
3. Importer’s Bank (Guarantor)
· Provides a guarantee (often in the form of an aval or letter of guarantee) on behalf of the importer.
· Assures the forfeiter that payment will be made on the due dates.
· Enhances the creditworthiness of the transaction and reduces risk for the forfeiter.
4. Forfeiter (Discounting Bank / Financial Institution)
· A specialized financial institution or bank that purchases the export receivables (promissory notes/bills) from the exporter without recourse.
· Pays the exporter upfront after deducting a discount fee.
· Collects the full payment from the importer (or importer’s bank) on maturity
· Party | Role |
Exporter | Sells goods; receives immediate payment from forfeiter |
Importer | Buys goods; pays over time through promissory notes |
Importer’s Bank | Guarantees payment to forfeiter |
Forfeiter | Buys receivables without recourse and collects payment |
Role of EXIM Bank in Forfaiting
The Export-Import Bank of India (EXIM Bank) plays a vital role in promoting and facilitating forfaiting transactions for Indian exporters.
1. Acts as an Intermediary
The EXIM Bank functions as a link between the Indian exporter and the overseas forfeiter (foreign financial institution). It ensures smooth coordination among all parties — exporter, importer, importer’s bank, and forfeiter.
2. Obtains Quotations
On receiving a request from the exporter, the EXIM Bank obtains indicative and firm quotes from international forfeiters. These quotes include details like:
o Discount rate
o Commitment fee
o Other charges
· This helps the exporter understand the cost of forfaiting and make informed decisions.
3. Receives and Forwards Documents
The EXIM Bank receives avaled bills of exchange or promissory notes (guaranteed by the importer’s bank) from the exporter. It forwards these documents to the forfeiter for discounting.
4. Arranges Discounted Payment
Once the forfeiting agreement is finalized, the EXIM Bank ensures that the discounted proceeds are remitted to the exporter promptly. The exporter thus receives immediate cash payment, improving liquidity.
5. Facilitates Fee Payments
· EXIM Bank issues certificates to allow exporters to remit commitment fees and other charges to the foreign forfeiter as per RBI regulations.
Function | Description |
Intermediary | Connects exporter and overseas forfeiter |
Quotation | Obtains discount rate, commitment fee, etc. |
Documentation | Handles export documents and guarantees |
Payment | Ensures discounted payment to exporter |
Compliance | Assists with fee remittance as per RBI norms |
Process
1. Export contract signed.
2. Importer gets Letter of Credit.
3. Exporter contacts forfeiter for terms.
4. Forfeiter quotes discount rate.
5. Goods shipped.
6. Promissory note issued.
7. Forfaiting agreement signed.
8. Forfeiter pays exporter at discount.
9. Collects from importer at maturity.
Cost Components
· Commitment Fee – For guarantee.
· Discount Fee – Interest deducted upfront.
Benefits to Exporter
· 100% finance
· Improved cash flow
· Reduced admin cost
· Advance tax refund
· Risk reduction (credit, currency, political)
· Increased trade opportunities
Factoring vs Forfaiting
Aspect | Factoring | Forfaiting |
Type | Short-term | Medium/Long-term |
Scope | Domestic + Export | Export only |
Recourse | With/Without | Always without |
Arrangement | Continuous | Single transaction |
Credit Period | Up to 180 days | 180 days–7 years |
Documents | Invoices | Promissory Notes/Bills |
Minimum Value | No limit | USD 250,000 |
Conclusion
· Factoring: short-term finance, systematic trade credit.
· Forfaiting: long-term export finance, reduces risk.
· Both help businesses improve liquidity and competitiveness
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