Dear All,
The term for today is “FACTORING”
Factoring is a financial transaction whereby an entity sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money. It is a method of freeing up funds locked in the form of debtors and also rules out the risk of non-recovery. The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights and risks associated with the receivables. Accordingly, the factor obtains the right to receive the payments made by the debtor for the invoice amount and must bear the loss if the debtor does not pay the invoice amount. Usually, the account debtor is notified of the sale of the receivable, and the factor bills the debtor and makes all collections. There are three main parts to a factoring transaction - the initial payout i.e. a percentage of the invoice face value that is paid to the seller immediately upon sale, the reserve i.e. the remainder of the total invoice amount held until the payment by the debtor is made and the fee associated with the transaction which is deducted from the reserve prior to it being paid back the seller. The factor's overall profit is the difference between the price it paid for the invoice and the money received from the debtor, less the amount lost due to non-payment, if any.
Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables, not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three - the one who sells the receivable, the debtor, and the factor.
Factoring is often used synonymously with invoice discounting. However, factoring is the sale of receivables whereas invoice discounting is borrowing where the receivable is used as collateral.
Bag Sir:
What is the legal recourse in case debtor fails to pay. Whether the same can be recovered from the entity selling its receivables?
Reply:
Dear Sir,
Factoring services are divided into two distinct types:
- Recourse Factoring
- Non-Recourse Factoring
Recourse Factoring: In case of recourse factoring, the factor can recover the amount from the firm/ company/ party selling its receivables in the event of debtors becoming bad.
Non-recourse Factoring: This type of factoring is usually more costlier of the two in which the factor cannot recover money from the firm/ company/ party selling its receivables ie the entire risk of bad debts falls on the factor.
However non-recourse factoring is not allowed in India, and hence in your case study, provided the same happens in India, the factor can recover all monies from the client ie the firm/company/party selling their receivables.
Parag Vaidya.
Article Assistant
Gokhale & Sathe
For further information, please refer
Regards,
CA Rahul Joglekar
Partner
Gokhale & Sathe
Chartered Accountants
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