8 most important Types of Factoring

The different types of Factoring are as follows:

For International Trade

1. Full Factoring

2. Recourse Factoring

3. Maturity Factoring

4. Advance Factoring

5. Undisclosed Factoring

6. Invoice Discounting

7. Bulk Factoring

8. Agency Factoring

A. Domestic Factoring

Factoring can be both domestic and for exports. In domestic Factoring, the client sells goods and services to the customer and delivers the invoices, order, etc., to the Factor and informs the customer of the same.

In return, the Factor makes a cash advance and forwards a statement to the client. The Factor then sends a copy of all the statements of accounts, remittances, receipts, etc., to the customer. On receiving them the customer sends the pay­ment to the Factor.

Different types of Domestic Factoring are as follows:

1. Full Factoring

This is also known as “Without Recourse Factoring “. It is the most comprehensive type of facility offering all types of services namely finance sales ledger administration, collection, debt protection and customer information.

2. Recourse Factoring

The Factoring provides all types of facilities except debt protection. This type of service is offered in India. As discussed earlier, under Recourse Factoring, the client’s liabil­ity to Factor is not discharged until the customer pays in full.

3. Maturity Factoring

It is also known as “Collection Factoring “. Under this arrangement, except pro­viding finance, all other basic characteristics of Factoring are present. The payment is ef­fected to the client at the end of collection period or the day of collecting accounts which­ever is earlier.

4. Advance Factoring

This could be with or without recourse. Under this arrangement, the Factor pro­vides advance at an agreed rate of interest to the client on uncollected and non-due receiv­ables. This is only a pre-payment and not an advance.

Under this method, the customer is not notified about the arrangement between the client and the Factor. Hence the buyer is unaware of factoring arrangement. Debt col­lection is organized by the client who makes payment of each invoice to the Factor, if ad­vance payment had been received earlier.

6. Invoice Discounting

In this arrangement, the only facility provided by the Factor is finance. In this method the client is a reputed company who would like to deal with its customers directly, includ­ing collection, and keep this Factoring arrangement confidential.

The client collects pay­ments from customer and hands it over to Factor. The risk involved in invoice discounting is much higher than in any other methods.

The Factor has liberty to convert the facility by notifying all the clients to protect his interest. This service is becoming quite popular in Europe and nearly one third of Factoring business comprises this facility.

7. Bulk Factoring

It is a modified version of Involve discounting wherein notification of assignment of debts is given to the customers. However, the client is subject to full recourse and he carries out his own administration and collection.

8. Agency Factoring

Under this arrangement, the facilities of finance and protection against bad debts are provided by the Factor whereas the sales ledger administration and collection of debts are carried out by the client.

B. International Factoring

Traditionally international trade is based on Letters of Credit. When the exporter knows the importer well with repetitive transactions, he may be willing to export on ‘ Open Ac­count ‘ basis. On open account the exporter ships the goods without letter of credit or advance payment.

Hence, it is credit risky for exporter. If credit is extended (say 90 days since), the exporter will be quite reluctant as he encounters a credit risk and hence invari­ably insists on L/C.

In advanced countries bankers do not make much of a distinction be­tween fund-based and non-fund based facilities and hence if they have to open L/C’s it may be at the cost of a reduced overdraft or bills limit for the importer.

The system of L/C’s operates on the “Doctrine of Strict Compliance ” which means the Letter of Credit opening bank will pay money to the exporter only when all the condi­tions listed in the Letter of Credit document are satisfied by the exporter/shipper of goods.

In many cases, the documents fail to pass the grade which means the exporter has simply lost the security available to him under the L/C. Further, now-a-days, goods move very fast and hence if documents are held up in banks for processing, it causes delay and inconve­nience to the importer.

In the light of the above, international trade has slowly started moving from cash to credit, and from L/C’s to open account sales. International Factoring is a service which helps the exporter and importer to trade on open account terms.

Types of International Factoring

The following are the important types of International Factoring. The client can choose any type of international factoring depending upon exporter – client needs and his price bearing capacity.

Two Factor Systems

This is the most common system of international factoring and involves four parties i.e., Exporter, Importer, Export Factor in exporter’s country and Import Factor in Importer’s country.

The functions of the export Factor are:

i. Assessment of the financial strength of the exporter

ii. Prepayment to the exporter

iii. Follow-up with the Import Factor

iv. Sharing of commission with the import Factor

The functions of the Import Factor are:

i. Maintaining the books of the exporter in respect of sales to the debtors in his country

ii. Collection of debts from the importer and remitting the proceeds to the exporter’s Factor

iii. Providing credit protection in case of financial inability on the part of any of the debtors

1. Single / Direct Factoring System

In this system, a special agreement is signed between two Factoring companies for single Factoring. Whereas in Two Factor System, credit is provided by import Factor and pre-payment, book keeping and collection responsibilities remain with export Factor.

For this system to be effective there should be strong co-ordination and co-operation between two Factoring companies. Pricing is lower when compared to Two Factor System.

2. Direct Export Factoring

Here only one Factoring company is involved, i.e., export Factor, which provides all services including finance to the exporter.

3. Direct Import Factoring

Under this system, the seller chooses to work directly with Factor of the importing country. The Factoring agreement is executed between the exporter and the import Factor. The import Factor is responsible for sales ledger administration, collection of debts and providing bad debt protection up to the agreed level of risk cover.

4. Back to Back Factoring

It is a very specialized form of International Factoring, used when suppliers are selling large volumes to a few debtors for which it is difficult to cover the credit risk in Interna­tional Factoring.

In this case, International Factor can sign a domestic Factoring agreement with the debtor whereby it will be getting the receivables as security for the credit risk taken in favour of Export Factor.