Page 182 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 11: Factoring

5. Distinguish between factoring and bill financing. Notes
6. Briefly discuss the appraisal technique followed by a factor.
7. What are the benefits, limitations and constraints of factoring in India?
8. Write a short note on international factoring.

Source: Sudhindra Bhat, Financial Management – Principles and Practice, Excel Books

Self Assessment

Fill in the blanks:
3. Generally the amount of money as advances to …………………………of the amount of the
bills (debt).

4. By reducing the size of its…………………., more money is made available for investment
in the firm’s growth.
5. The ………………….in the cash flow will determine the size of the cash balance a business.

11.3 Role of Factoring in Receivables Management

The credit management normally gives rise to two difficult problems:
1. Problem of raising funds to finance and receivables, and
2. Problems relating to collection defaults and delays.

Particularly in case of firms having large number of customers buying on credit, lot of time and
efforts are to be spent on receivables management. In such cases, the firm can assign its credit
management and collection to specialized organizations called factoring organizations. These
agencies manage, finance and collect the receivables of the firms. They are called factoring
organizations, which are very popular in advanced countries like USA and U.K.
Factoring is the purchase of accounts receivables at a discount in order that the supplier/creditor
can receive their cash straight away. A business will consider factoring receivables when facing
a period of cash flow problems.
The factor purchases the client’s debtors and in relation thereto, controls the credit extended to
the customer and administers the sales ledger. The agreement between the firm and factor
specifies the factoring procedure. Usually, the firm sends the customer’s order to the factor for
evaluation purpose. The factor evaluates the customer’s credit worthiness and if satisfies, agrees
to buy the receivables. After receiving the approval, the firm sells the goods to the customer.
The customer is informed that his account is sold to the factor and instructs him to pay the dues.
When receivables are sold to a factor any bad debts loss should be protected by the factor.
Factoring plays a very important role in receivables management since:

1. Factoring is one of the quickest way to produce a cash inflow into a business.
2. Administrative costs to the business are reduced as all collections activity is undertaken
by the factoring company.

3. Time costs are reduced in sales transaction and invoice processing. The invoice is produced,
factored and filed. All other activities are carried out by the factoring company.
4. The business no longer carries the risk of bad debts and defaulting debtors. The factoring
company carries this burden.

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