Operational problems in Factoring

The factoring service in India is at a nascent stage. Its quantitative growth is relatively limited. Its future depends on the removal of a number of genuine operational obstacles.

Credit Information: The factors do not have access to any authentic common sources of information. They have to depend on their own data-base for credit evaluation of clients. The system of multiple data bases by individual factors is not only expensive but is also devoid of uniformity and obviously is a serious impediment in the growth of factoring services. The establishment of specialized credit information agency/bureau is urgently called for.

Stamp Duty: The assignment of debt attracts stamp duty charged by the states which is as high as 15 per cent on the amount exceeding Rs 2 lakh. It inflates the cost of operations of service and erodes the profitability of the factors. There is a very strong case for waiving on stamp duty on assignment of debt factors.

Legal Framework: Changes are also called for in other components of the present legal framework to ensure success of factoring in India.

Funding: The factors in India are not allowed access to wider funding sources on scales available to other finance companies. Virtual dependence on equity funds does not permit them optimal funding. For a cost effective financing of these companies, greater access to the debt and the money market like the leasing and other finance companies is an urgent necessity.

Disclaimer Certificate: To purchase a book debt of its clients, a factor needs disclaimer certificate from banks. In the present context they are reluctant to issue such a certificate. The factoring companies should be allowed to purchase book debts without requiring such a certificate from banks.

Limited Coverage: At present only domestic factoring of the advance with recourse is permitted and offered in India. Although the ECGC and SBI FACS have initiated measures for export factoring no headway has been made. It is high time to provide export factoring to Indian exporters.

An overview:

Factoring means the sale of receivables (book debts) by a firm (client) to a financial intermediary (factor) who pays when they are collected, or on a guaranteed payment date. It basically involves transfer of collection of receivables and the related maintenance of records from the client to the factor. In essence, factoring is a source of financing of receivables and facilitates the process of their collection.

Depending on the type of factoring, the main functions of factor, in general terms, are five fold: (1) maintenance of sales ledger, (2) collection of receivables, (3) financing of trade debts, (4) assumption of credit risk/control/ protection and (5) provision of advisory services. For providing these services, the factors levy two types of charges. They charge for collection of receivables and sales ledger administration in the form of a commission/fee payable in advance expressed as a flat percentage of the value of the debt purchased. The charge for short term financing in the form of advance part payment is an interest charge/discount charge for the period between the date of advance payment and the date of collection/guaranteed payment due.

On the basis of the features built into the factoring deal to cater to the varying needs of the trade/clients, there are different types of factoring. The main classification of factoring arrangements is: (1) recourse and non-recourse based on the assumptions of credit risk associated with the collection of the receivables. (2) advance, maturing and participation factoring related to the time of payment on account of receivables by the factor, to the client, (3) full factoring, (4) disclosed and undisclosed factoring on the basis of the disclosure/non-disclosure of the name of the factor in the invoice, (5) domestic and export / cross border / international factoring based on the domicile of the parties involved.

There is no codified legal framework to regulate factoring in India. The legal relationship between the factor and the client is governed by the provisions of the factoring contract.

Domestic factoring as a fund based service, differs from bills discounting, and export factoring from forfaiting which finances deferred credit transactions related to exports.

Factoring offers several advantages to a client including: (1) off-balance sheet financing, (2) reduction in current liabilities, (3) improvement in current ratio; (4) higher credit standing (5) improved efficiency, (6) reduction of costs (7) additional sources of funds and so on. However, since it involves a cost in terms of fee and discount charge and evaluation of factoring should be done as a cost benefit analysis resorting to factoring.