Page 178 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 11: Factoring

Factoring may also be defined as a continuous relationship between financial institution (the Notes
factor) and a business concern selling goods and/or providing service (the client) to a trade
customer on an open account basis, whereby the factor purchases the client’s book debts (account
receivables) with or without recourse to the client - thereby controlling the credit extended to
the customer and also undertaking to administer the sales ledgers relevant to the transaction.
The term “factoring” has been defined in various countries in different ways due to non-
availability of any uniform codified law. The study group appointed by International Institute
for the Unification of Private Law (UNIDROIT), Rome during 1988 recommended, in simple
words, the definition of factoring as under:

“Factoring means and arrangement between a factor and his client which includes at least two of
the following services to be provided by the factor:

Finance
Maintenance of accounts
Collection of debts
Protection against credit risks”.
The above definition, however, applies only to factoring in relation to supply of goods and
services in respect of the following:
1. To trade or professional debtors
2. Across national boundaries

3. When notice of assignment has been given to the debtors.
The development of factoring concept in various developed countries of the world has led to
some consensus towards defining the term. Factoring can broadly be defined as an arrangement
in which receivables arising out of sale of goods/services are sold to the “factor” as a result of
which the title to the goods/services represented by the said receivables passes on to the factor.
Hence the factor becomes responsible for all credit control, sales accounting and debt collection
from the buyer(s).

Banks have been given more freedom of borrowing and lending both internally and externally,
and facilitated the free functioning of the banks in lending and investment operations. From
1994 banks are allowed to enter directly leasing, hire purchasing and factoring services, instead
through their subsidiaries. In other words, Banks are free to enter or exit in any field depending
on their profitability, but subject to some RBI guidelines.
Banks provide working capital finance through financing receivables. A “Factor” is a financial
institution, which renders services relating to the management and financing of sundry debtors
that arises from credit sales. Factoring is a popular mechanism of managing, financing and
collecting receivables in developed countries like USA and UK, and it has spread over to a
number of countries in recent past including India. In India, factoring service started in April
1994, after setting up of subsidiaries. It is yet at the formative stage. In India, there are only four
public sector banks that offer factoring related service in the respective regions of the country
(authorized by RBI) viz., State Bank of India {subsidiary State Bank of India Factoring and
Commercial Services Limited), Canara Bank (Canara Bank Factoring Limited), Allahabad Bank
and Punjab National Bank to cater to the needs of the Western, Southern, Eastern and Northern
regions, respectively.
Factoring is a financial service designed to help firms to arrange their receivable better. Under a
typical factoring arrangement a factor collects the accounts on due dates, effects payments to the
firm on these dates and also assumes the credit risks associated with the collection of the accounts.

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