Factoring
Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT
Meaning
Factoring is when a firm sells its receivables to a financier at a discount to get cash immediately. Receivables are the money its customers still owe it. The financier is called the "factor" and later collects the full amount from those customers. This eases the firm's working-capital squeeze, which is the shortage of day-to-day cash it faces while waiting to be paid. In India it is governed by the Factoring Regulation Act 2011. A 2021 amendment allowed more NBFCs to act as factors.
Example
A small textile unit in Tiruppur supplies cloth worth Rs 10 lakh to a garment exporter, who will pay after 90 days. The unit sells this invoice to a factor today for Rs 9.7 lakh. The unit gets cash now, and the factor earns Rs 30,000 when the exporter pays the full amount.
Don't confuse with
- Loan against receivables: here the firm borrows and still owns the receivables. In factoring, the receivables are sold to the factor.
- TReDS: an electronic platform where many financiers bid to discount MSME invoices. Factoring is the underlying deal, and it can happen with a single financier outside any platform.
Related concepts
- CASA ratio
- Credit-deposit ratio
- Base rate
- Marginal Cost of Funds based Lending Rate
- External Benchmark Lending Rate
- Loan-to-value ratio
- Adverse selection
- Credit information company
- Letter of credit
- Trade Receivables Discounting System