The factor maintains the clients’ sales ledger. On transacting a sales deal, an invoice is sent by the client to the customers and a copy of the same is sent to the factor. The ledger is generally maintained under the open item method in which each receipt is matched against the specific invoice. The customer’s account clearly reflects the various open invoices outstanding on any given date. The factor also periodic (fortnightly/weekly depending on the volume of transactions) reports to the client on the current status of his receivables, receipts of payments from the customers and other useful information. In addition, the factor also maintains a customer wise record of payments spread over a period of time so that any change in the payment pattern can be easily identified.
Provision of collection Facility: The factor undertakes to collect the receivables on behalf of the client relieving him of the problems involved in collection, and enables him to concentrate on other important functional areas of the business. This also enables the client to reduce the cost of collection by way of savings in manpower, time and efforts. The use of trained manpower with sophisticated infrastructural back up enables a factor to systematically follow up and to make timely payments on the debtors. Also, the debtors are more responsive to the demands from a factor being a credit institution.
Collection of receivables can be considered as the most important function of a factor. He is generally not required to consult the client with regard to the collection procedure. But he may consult the client if legal action has to be initiated in case of non-payment.
Financing Trade Debts: The unique feature of factoring is that a factor purchases the book debts of his client at a price and the debts are assigned in favor of the factor who is usually willing to grant advances to the extent of 80 per cent of the assigned debts. Where the debts are factored with recourse, the finance provided would become refundable by the client in case of non-payment by the buyer. However, where the debts are factored without recourse, the factor’s obligation to the seller becomes absolute on the due date of the invoice whether or not the buyer makes the payment.
Credit Control and Credit Protection: Assumptions of credit risk is one of the important functions of a factor. This service is provided where debts are factored without recourse. The factor in consultation with the client fixes credit limits for approved customers. Within these limits, the factor undertakes to purchase all trade debts of the customer recourse. In other words, the factor assumes the risk of default in payment by the customers. Arising from this function of the factor, there are two important incidental benefits accruing to the client: firstly factoring relieves the client of the collection work; secondly with access to extensive information available on the financial standing and credit rating of individual customers and their track record of payments, the factor is able to advise the client on the credit worthiness of potential customers leading to better credit control.
Operationally, the line of credit/credit limit up to which the client can sell to the customer depends on his financial position, his past payment record and the value of the goods sold by the client to the customer. One approach followed by the factors is to define the monthly sales turnover for each customer which will be automatically covered by the approved credit limit. If, for instance the approved limit for a customer is Rs 5 lakh and the average collection period is 60 days, sales up to Rs 2.5 lakh [(5X30)/60] per month will be automatically covered. Alternatively, some factors provide periodic reports to the clients on customer wise outstanding and ageing schedules to enable the clients to asses the extent of credit utilization before any major sale is made. The credit worthiness of customers is assessed by the factors on the basis of information from a number of sources such as credit rating reports, if available; bank reports and trade references; analysis of financial statements on the basis of current ratio, quick ratio, net profit margin and Return on Investment (ROI) prior collection experience and customer visits.
Advisory Services: These services are spin offs of the close relationship between a factor and a client. By virtue of their specialized knowledge and experience in finance and credit dealings and access to extensive credit information; factors can provide a variety of incidental advisory services to their clients.
1. Customer’s perception of the client’s products, changes in marketing strategies emerging trends etc.,
2. Audit of the procedures followed for invoicing delivery and dealing with sales returns;
3. Introduction to the credit department of a bank / subsidiaries of banks engaged in leasing hire purchase merchant banking etc.