## Factoring of Receivables
Factoring means the outright sale of receivables to a third-party agency called a Factor (typically a bank or NBFC). The factor pays cash upfront (after deducting fees) and collects directly from customers.
### Key Contrast with Pledging
| Dimension | Pledging | Factoring |
|---|---|---|
| Nature | Loan against receivables | Sale of receivables |
| Balance Sheet | Debt appears | Off-balance sheet |
| Collection | Firm collects | Factor collects |
| Repayment Liability | Yes | No |
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## Types of Factoring
1. Recourse Factoring: If the customer defaults, the firm must compensate the factor. Risk remains with the firm. Lower fee.
2. Non-Recourse Factoring: Factor absorbs the full risk of non-payment. Charges a higher fee to compensate.
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## Advantages of Factoring
- Immediate cash inflow
- Not a loan — no debt on balance sheet
- No repayment liability
- Collection process outsourced
- Efficient cash flow management
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## Evaluation of a Factoring Proposal
Use this structured format to decide whether to accept or reject factoring:
### A. Benefits (Annual Savings)
| Item | Calculation |
|---|---|
| Credit administration cost saved | Actual admin cost p.a. |
| Bad debts avoided | Bad debt % × Credit Sales |
| Interest saved (faster collection) | Interest rate × reduction in debtors |
| Total Benefits (A) | Sum of above |
### B. Costs
| Item | Calculation |
|---|---|
| Factoring commission | Commission % × Total Credit Sales |
| Interest on advance from factor | Interest rate × Advance amount |
| Total Costs (B) | Sum of above |
### C. Net Benefit = A − B
### Decision Rule
- Accept if Net Benefit > 0 OR effective cost of factoring < existing borrowing cost.
- Reject if factoring cost > alternative financing sources.