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CORPORATE FINANCE

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ABHIJEET CHANDRA
Vinod Gupta School of Management, IIT KHARAGPUR

Lecture 35: Credit Management - III

CONCEPTS COVERED

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⮚ Factoring

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⮚ Bills Discounting

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Credit Management
Factoring
Goods sol d on Credit
Company/Seller

Factor Pays the

Receivables
(at a Discount)

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Factor Buyer/Customer

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Receivables Assigned
to the Factor

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Debtors

likely after the due date)

Debtors Pay the Dues (most
Credit Management
Factoring
• Factoring Business: the business of acquisition of receivables of assignor by accepting
assignment of such receivables or financing, whether by way of making loans of
advances or in any other manner against the security interest over any receivables
(The Factoring Act, 2011/RBI).
• However, credit extended by banks in ordinary course of business against the

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security of receivables not included in factoring business.
• Some of the non-banking finance companies (NBFC)- Factors registered with

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the RBI
(as on Jan. 31, 2021):

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• Canbank Factors Ltd., Bengaluru
• India Factoring & Finance Solutions Pvt. Ltd., Mumbai
• SBI Global Factors Ltd., Mumbai
• IFCI Factors Ltd., New Delhi
• Pinnacle Capital Solutions Pvt Ltd., Patna
 Credit Management 500000
Factoring Volume in India (Million Rs.)*

Factoring 450000
400000
• Factoring: a mechanism for the management of 350000
300000
receivables that are typically a significant part 250000
of the current assets of a company. 200000
150000
• Quick way to access the short-term financing 100000
and to minimize default risks and payment

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50000
delays by buyers/debtors. 0
2013 2014 2015 2016 2017 2018

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• Major source of ST funds/liquidity for SMEs. 2019

• Process: The seller assigns the receivables to a

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factor at discount; the factor then collects the
receivables in due time.
• Significant growth in factoring volume in India
in recent years.
*Source: SME Finance Forum (2020)
Credit Management
Factoring
• The Factor is expected to perform at least two of the following functions:
i. Provide finance for the supplier, including loans and advance payments;
ii. Maintenance of accounts (ledgering related to the receivables);
iii. Collection of accounts (ledgering related to the receivables); and
iv. Protection against default in payments by debtors

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• As practice, a customer whose dues are assigned to a factor is informed about the
assignment and instructed to make payment directly to the factor.

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• Micro, small, and medium enterprises (MSMEs) in India face issues of

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liquidity and delayed payments in recent years. These factors cause
challenges for availability of working capital.
• Factoring and bill discounting as a product are potential tools to provide
liquidity to the MSMEs. directly to the factor.
Credit Management
Factoring
Example: Given the following information for a firm:
Credit sales: Rs. 80 Lakh; Average collection period: 80 days; Bad debt losses: 1% of credit sales;
Usual spending on administration of credit sales (e.g., telephone, salary of one officer and two
clerks who handle credit checking, collection, etc.): Rs. 1,20,000.
A factor is willing to buy the firm’s receivables, at 2% commission, and will pay an advance

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against the receivables (@ interest rate of 18%), after withholding 10% as reserve.

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What should the firm do?

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Credit Management
Factoring and Bills Discounting
Factoring Bills Discounting
Efficient and specialized management of Type of short-term securitized
receivables and a tool to enhance borrowings
liquidity
Seller protected from bad While using bills discounting, the seller

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debts/defaults of debtors. has no protection from defaults of
debtors.

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Easy to adopt for every scale of business Difficult for businesses with large
as the receivables are assigned as number of customers/debtors with

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blocks to the factor. varying amounts; impractical to draw
large number of bills.

Method of short-term financing Source of short-term funds

CONCLUSION

• In most cases, companies adopt the best practices for collection management
that involves setting up of a system to accelerate payments.

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• Factoring is one such tool where seller sells receivables to a third part at a

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discount and receive funds against the same.
• Similar to bills discounting, factoring is used to raise short-term finances

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against receivables.
• Management of working capital is critical to successful operations in
any
business entity and it includes equal, if not more, attention to the
management of payables, inventory, cash, and receivables.
REFERENCES

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⮚ Corporate Finance, 2nd ed. (2012), Clayman et al. Wiley

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⮚ Financial Management, 14th ed (2021), Pandey, Pearson

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