ADVANTAGES
Benefits of Factoring to Clients
Under the factoring arrangement the client receives prepayment upto 80-90 percent of the invoice value immediately and the balance amount after the maturity period. This helps the client to improve cash flow position which enables him to have better flexibility in managing working capital funds in an efficient and effective manner.
If the client avails the services of the factor in respect of sales ledger administration and collection of receivables, he need not have any administrative set up for this purpose. Naturally this will result into a substantial saving in time and cost of maintaining own sales ledger administration and collecting receivables from the customer. Thus, it will reduce administrative cost and time.
When without recourse factoring arrangement is made, the client can eliminate the losses on account of bad debts. This will help him to concentrate more on maximizing production and sales. Thus, it will result in increase in sales, increase in business and increase in profit.
The client can avail advisory services from the factor by virtue of his expertise and experience in the areas of finance and marketing. This will help the client to improve efficiency and productivity of his organization. Besides this, with the help of data base, the factor can readily provide information regarding product design/mix, prices, market conditions etc., to the client which could be useful to him for business decisions.
The above mentioned benefits will accrue to the client provided he develops a better business relationship with the factor and both of them have mutual trust in each other.
DISADVANTAGES
1) Image of the client may suffer as engaging a factoring agency is not considered a good sign of efficient management.
2) Factoring may not be of much use where companies or agents have one time sales with the customers.
3) Factoring increases cost of finance and thus cost of running the business.
4) If the client has cheaper means of finance and credit (where goods are sold against advance payment), factoring may not be useful.
FACTOTING ORGANISATION IN INDIA
India's first factoring company was set up jointly by Can bank financial services Ltd. , Rashtriya chemicals and Fertilizer Ltd.
Reserve bank of India permitted Canara bank to set-up Corporate subsidiary with Rs. 10 crore capital in cooperation with Andhra Bank and Small Industries Development Bank to render factoring services in southern region. State Bank of India and Punjab and Sind bank have been permitted to form subsidiary to provide factoring services in northern region. With a view to catering to the needs of eastern region United Commercial Bank, United Bank o India and Allahabad Bank have been permitted to float subsidiary with Rs. 5 crores.
The entry of factoring agencies in Indian financial markets has created fear among the bankers that they may loose the entire account. However, this fear is misplaced. Customers of one bank have freely gone to merchant banking, leasing or volume capital subsidiaries of some other banks and utilized their services. There are hardly any cases, where the accounts were shifted.
ADVANTAGES OF FACTORING (Indian Perspective)
Reduction of current liabilities:- From the factoring proceeds of Rs 64 lakh, the bank borrowings are liquidated to the extent of Rs 40 lakh. The balance of Rs 24 lakh can be used by the client for paying off other current liabilities comprising of trade creditors for goods and services. Creditors for expenses, loan instalments payable, statutory liabilities and provisions. The client may meet any of these obligations with the balance of Rs 24 lakh. The net effect is to reduce current liabilities by Rs 64 lakh.
Improvement in current ratio:- as the factoring transaction is of the balance sheet, it removes from the asset side receivables factored to the extent of the prepayment made and on the liabilities side, the current liabilities are also reduced.
Higher credit standing:- there are several reasons why factoring should Improve a client's standing. With cash flow accelerated by factoring, the client is able to meet his liabilities promptly as and when they arise. The factor's acceptance of the client's receivables itself speaks highly of the quality of the receivables. In the case of non-recourse factoring, the factor's assumption of credit risk relics the client, to a significant extent, from the problem of bad debts. This enables him to minimize his bad debts reserve.
Improved efficiency:- In order to accelerate cash flow, it is essential to ensure the flow of critical information for decision making and follow-up and eliminate delays and wastage of man-hours. This requires sophisticated infrastructure for high level specialization in credit control and sales ledger administration. Small and medium-sized units are likely to face a recourse constraint in this area. Factoring is designed to place such units on the same level of efficiency in the areas of credit control and sales ledger administration as that of the more sophisticated large companies.
More time for planning and production:- In any business concern, it is inevitable that a certain proportion of management time has to be diverted to credit control. Large companies can afford to have special departments for the purpose. However smaller units cannot afford it. The factor undertakes the responsibility for credit control, sales ledger administration and debt collection problems. Thus, the client can concentrate on functional areas of the business line planning, purchase, production, marketing and finance.
Reduction of cost and expenses:- Since the client need not have a special administrative set-up to look after credit control, he can have the benefit of reduced overheads by way of savings on manpower, time and efforts. With the steady and reliable cash flow facilitated y factoring, the clients have many opportunities to cut costs and expenses like taking supplier's prompt payment and quantity discounts, ordering for materials at the right time and at the right place, avoidance of disruption in the production schedule, and so on.
Additional source:- The supplier gets an additional source of funding the receivables which eliminates the uncertainty associated with the collection cycle. More importantly, funds from a factor are an additional source of finance for the client outside the purview of bank credit.
Importance of a written credit and collection policy
Many companies do not have a written credit policy. There are a variety of reasons for fills. Perhaps the most prevalent is the belief that a written policy is more trouble than it is worth, or that once completed, the policy will quickly be forgotten or ignored. But among the benefits of a written policy are that the policy will reduce bias and subjectivity in the credit decisions being made, the process becomes more predictable (something sales and senior management will appreciate); and since everyone understands the ground rules, exceptions will be made based on business considerations.
There are a number of advantages/valid reasons for investing the time and effort to develop a written credit policy. Among the more important reasons are:
* A written policy is one way to ensure continuity in the department in the event that key personnel leave the credit department.
* A written policy helps ensure consistent credit decisions--meaning that all customers will be treated fairly.
* It can he used as a training tool.
* It can be used to help evaluate or benchmark job performance against established standards documented in the policies mad procedures manual.
Relevance: A policy must be relevant to the way the credit department actually operates. To be relevant, the credit polity must be current, and it must be kept current.
Key Questions a Credit Policy Must Answer. A well-written credit policy will answer the following questions:
* Will a credit application be required? Must it be signed? If so, by who?
* Will the application include a personal guarantee? When must it be signed?
* Will the guarantor be required to provide personal financial statements?
* How will the creditworthiness of the guarantor he confirmed?
* What are the company's standard terms of sale?
* Who must approve requests for extended dating, and what form will this approval take?
* What is the credit manager's authority limit? What are the consequences of exceeding this authority limit?
* Who in management can override credit decisions? What form does that override take?
* Will the company sell to a debtor in possession? If so, raider what conditions?
* What forms of security will the company accept to reduce credit risk?
* If security instruments are used, what is the acceptable language or oilier criteria required for approval?
* How frequently will credit files be updated?
* Who will review the information, and what constitutes an unacceptable credit risk?
* How frequently will customers be contacted about past due balances? How soon will the customers be contacted?
* At what point may orders be placed on credit hold? Who authorizes credit holds?
* Who must be informed of the credit hold? How will this notification take place?
* Who has the authority to withdraw open account terms?
* Who has the authority to place accounts for collection?
* What methodology will be used to calculate bad debt reserves?
* When will accounts be considered eligible for write off?
Credit Policy Do's and Don'ts. Whether you are writing a new policy and procedure manual, or you are reviewing and updating your current manual, you should keep these ideas in mind:
* Always incorporate the needs and interests of other areas within your company. A credit policy should accomplish both sales and financial goals.
* Always have the most senior executive in the organization sign-off on the credit policy as representative of the way your company wants its credit department to do business.
* Always incorporate an avenue for exception approval, with approval required from both a sales and finance point of view--with escalation to the most senior credit manager as the ultimate tiebreaker.
* Don't keep your credit policy a secret. Be certain to share it with your sales department and with other senior managers.
* Don't make your policy so rigid that you, the credit manager, do not have a certain amount of "wiggle room" in your credit decision-making process.
* Don't make the policy so vague or flexible that it is subject to interpretation by each member of the credit department or even worse, sales.
* Do update your credit policy so it does not go stale.
* Do establish a specific hierarchy within the credit operation. Make certain that everyone with credit granting authority knows his or her credit approval limit.
* Do make sure your policy explicitly states that the credit department is "pro" sales. Make certain you are looking for reasons to release orders, not excuses to hold orders.
* Do include policies intended to manage marginal accounts.
* Do include policies and procedures intended to minimize credit risk and the potential for bad debt losses.
* Do include instructions about how confidential information will be kept confidential.
* Do include examples of actual or potential conflicts of interest.
* Do state clearly in the manual that employees may not engage in unethical or unlawful behaviour and include examples of these prohibited behaviours.
* Do not create a credit policy that has the effect of isolating the credit department from the rest of the company. The credit department must be a part of the success of the company as a whole, and not apart from the company's success or failure.
* Do follow the policy consistently: Haphazard adherence to a policy could result in legal liability to your company.
An area that often causes problems for the credit department involves the use of credit holds. Salespeople often think the credit department is too quick to impose credit holds, but if the credit policy manual addressed this issue it would be clear to the sales department and to senior management why the decision to hold orders was made. It should be emphasized that a credit hold is most appropriate when there is a real chance of non-payment. When used as a tool to motivate slow payers to pay up, the collections process has failed.
(www.allbusiness.com)
Chapter 3: Research Methodology
Research Objective: To understand the credit policy and importance of various
factors associated with it.
Co-objective:
To understand the methods used to judge with credit worthiness.
To understand the goal of credit management.
To find out the most appropriate method for monitoring receivables.
Research Design:
A questionnaire is developed and administered to Finance and Marketing department of the organization as receivables is a combined area of both of the departments. Both qualitative and quantitative primary is collected and analysed.
Data Collection Method
The primary data was collected by the questionnaire administered to the people working in Finance and marketing department of Caparo Tubes India, Dewas.
Questionnaire
Questionnaire is an important step in formulating a research design. Once the researcher has specified the nature of research design, and determined the scaling procedures, he or she can develop a questionnaire.
Objectives of a questionnaire:
Any questionnaire has three specific objectives.
It must translate the information needed into a set of specific questions that the respondents can and will answer.
It must uplift, motivate and encourage the respondent to become involved in the interview, to cooperate, and to complete the interview. Incomplete interviews have limited usefulness at best.
It should be able to minimize response errors.
Sampling Plan
The plan for sampling consists of population and sample definition.
Sample size: A total of 32 responses were collected.
Sampling Unit: Concern people in Finance and Marketing department.
Extend: Caparo Tubes India
Time: June-2010
Contact Method: Questionnaires filled through E-mail.
Significance of Study
The need of the study arises because the firm does not have any written credit policy which can be used to grant credit. The study also focuses on the factoring option for collection of receivables for the firm.
Chapter 4: Data Analysis
Analysis:
Written Credit Policy is important?
Figure 3: Credit policy
Interpretation:
From the research it seems that 75% people think that it's important to have a written credit policy. 25% people think that it doesn't make any difference whether we have a credit policy or not.
Method to judge credit worthiness
Figure 4: Methods to judge
Interpretation:
The research shows that more than 45% of people think that financial statement of the customer is best instrument to judge credit worthiness of a customer followed by Bank reference, Trade reference. Credit rating and reports are yet not considered a reliable source for judging credit worthiness.
Table 1: Crosstabulstion of Methods to Judge
Method_Judge * Written_credit_policy Crosstabulation
Written_credit_policy
Total
Yes
No
Method_Judge
Financial statements
Count
12
3
15
% of Total
37.5%
9.4%
46.9%
Bank Reference
Count
6
0
6
% of Total
18.8%
.0%
18.8%
Trade reference
Count
3
3
6
% of Total
9.4%
9.4%
18.8%
Credit rating and reports
Count
3
2
5
% of Total
9.4%
6.3%
15.6%
Total
Count
24
8
32
% of Total
75.0%
25.0%
100.0%
Figure 5: Crosstabulation of Methods to judge
Interpretation:
The people who are in favour of written credit policy also think that financial statement is the best way to judge credit worthiness. People with notion against written credit policy thinks financial statement and trade references both can be used to take the decision on credit worthiness.
Duration in which credit limit should revise
Figure 6: Revise duration
Interpretation:
The result shows that the credit limit for the customers should revise every year so that the credit limit will be as per the financial condition of the customer.
Primary Goal of Credit Management
Figure 7: Goal of Credit Management
Interpretation:
The result shows that the primary goal of credit management is "To maximize the value of the firm" which has nearly 45% people agree with the statement. "To control cost of credit" emerges as second important goal which is fulfilled by the credit management followed by maintenance of investment in debtors and obtaining optimum value of sale.
Methods to Monitor Receivables
Figure 8: Monitoring methods
Interpretation:
Ageing schedule is the most suited way to monitor the receivables with more than 60% people agreed on this. Average collection period was the second most trusted way to monitor the receivables.
Factoring can help in reducing bad debt.
Figure 9: Factoring
Interpretation:
As the result shows that more than 55% people think that factoring can help in reducing the bad debt.
Most suitable factoring for Indian firms
Figure 10: Most suitable factoring type
Interpretation:
Bulk /agency factoring service is most relevant factoring service in Indian context followed by the Full service resource factoring and Non-notification factoring options.
Factors affecting Investment in Receivables
Table 2: Factors For Investment in Receivables
Descriptive Statistics
N
Minimum
Maximum
Mean
Std. Deviation
Volume_of_credit_sale
32
1.00
4.00
2.6563
.90195
Credit_policy
32
3.00
5.00
4.0000
.67202
Trade_terms
32
1.00
3.00
2.2500
.71842
Seasonality_of_business
32
1.00
3.00
2.0937
.64053
Collection_policy
32
2.00
4.00
3.3125
.64446
Bill_discounting
32
1.00
4.00
2.8125
.89578
Valid N (listwise)
32
Figure 11: Factors affecting receivables
Interpretation:
The mean for various services implies that Credit Policy is a important factor for the investment in receivables followed by the collection policy and Bill discounting all these factors valued more than factors like credit sales volume which was initially seems to be a vital factor for investment in receivables.
Services Provided by Factoring Organization
Table 3:Services of factoring
Descriptive Statistics
N
Minimum
Maximum
Mean
Std. Deviation
Credit_administration
32
1.00
4.00
2.8125
.93109
Credit_collection
32
3.00
5.00
4.0000
.67202
Credit_protection
32
3.00
4.00
3.5938
.49899
Financial_assistance
32
1.00
3.00
1.9687
.73985
Financial_counseling
32
1.00
3.00
2.0000
.67202
Valid N (listwise)
32
Figure 12: Comparison of services
Interpretation:
The most important and primary service provided by the factoring organisation is Credit collection having a mean value of 4. Protection of credit was ranked second important service which is provided by the factoring organisation.
Factor Analysis
Factor analysis is a general name denoting a class of procedures primarily used for data reduction and summarization. In this survey, there are a large number of variables, most of which are correlated and which must be reduced to a manageable level in form of few factors.
Objectives - The objectives behind conducting factor analysis are-
To explore the hidden latent structure of the variables which lead to
grant of Credit.
To reduce the number of variables to a few factors and then analyze them.
Correlation matrix
Table 4:Correlation matrix
V1
V2
V3
V4
V5
V6
V7
V8
V9
V10
V11
V12
V1
1.000
-.284
-.132
-.319
-.255
.829
-.286
.917
-.041
.905
-.183
-.142
V2
-.284
1.000
.184
.878
.898
-.339
.971
-.272
.187
-.297
.226
.199
V3
-.132
.184
1.000
.141
.165
-.231
.148
-.057
.852
-.302
.834
.924
V4
-.319
.878
.141
1.000
.847
-.376
.911
-.365
.191
-.282
.187
.153
V5
-.255
.898
.165
.847
1.000
-.305
.872
-.289
.272
-.267
.314
.243
V6
.829
-.339
-.231
-.376
-.305
1.000
-.345
.715
-.117
.783
-.274
-.250
V7
-.286
.971
.148
.911
.872
-.345
1.000
-.322
.168
-.241
.134
.160
V8
.917
-.272
-.057
-.365
-.289
.715
-.322
1.000
.002
.823
-.112
-.121
V9
-.041
.187
.852
.191
.272
-.117
.168
.002
1.000
-.157
.697
.783
V10
.905
-.297
-.302
-.282
-.267
.783
-.241
.823
-.157
1.000
-.401
-.327
V11
-.183
.226
.834
.187
.314
-.274
.134
-.112
.697
-.401
1.000
.903
V12
-.142
.199
.924
.153
.243
-.250
.160
-.121
.783
-.327
.903
1.000
If the correlation between all the variables is small, factor analysis may not be appropriate. We would also expect that variables that are highly correlated with each other would also highly correlate with same factors. Formal statistics are available for testing the appropriateness of the factor model. Bartlett's test of sphericity can be used to test the null hypothesis that variables are uncorrelated in the population; in other words, the population correlation matrix is an identity matrix. Another test is the KMO measure of sample adequacy. This index compares the magnitudes of the observed correlation coefficients to the magnitudes of the partial correlation coefficients. Small values of less than 0.5 indicate that correlations between pairs of variables cannot be explained by other variables and factor analysis may not be appropriate.
Table 5: KMO and Bartletts Test
KMO and Bartlett's Test
Kaiser-Meyer-Olkin Measure of Sampling Adequacy.
.699
Bartlett's Test of Sphericity
Approx. Chi-Square
501.479
Df
66
Sig.
.000
The value of KMO Test is .699 which means that the degree of common variance among the 12 variables is "good". If a factor analysis is conducted, the factors extracted will account for substantial amount of variance.
Bartlett's Test
H0- The population correlation matrix is an identity matrix.
H1- The population correlation matrix is not an identity matrix.
Test Result:
ï£2 = 501.479
df = 66
p<0.05
Statistical Decision:
Null hypothesis is rejected. The sample inter-correlation matrix did not come from a population in which the inter-correlation matrix is an identity matrix.
Result of the Initial Solution
The Eigen values associated with each factor represent the variance explained by that particular linear component and SPSS also displays the Eigen values in terms of the percentage of variance explained. SPSS extracts all the factors with Eigen value more than 1.
Table 6:Total Variance Explained
Total Variance Explained
Component
Initial Eigenvalues
Extraction Sums of Squared Loadings
Rotation Sums of Squared Loadings
Total
% of Variance
Cumulative %
Total
% of Variance
Cumulative %
Total
% of Variance
Cumulative %
1
5.393
44.940
44.940
5.393
44.940
44.940
3.692
30.764
30.764
2
2.967
24.721
69.661
2.967
24.721
69.661
3.554
29.619
60.383
3
2.401
20.012
89.673
2.401
20.012
89.673
3.515
29.291
89.673
4
.342
2.853
92.527
5
.294
2.449
94.976
6
.199
1.655
96.631
7
.163
1.359
97.989
8
.123
1.026
99.016
9
.050
.415
99.431
10
.034
.284
99.715
11
.028
.230
99.945
12
.007
.055
100.000
Factor I
The 1st factor has an Eigen Value=5.359. Since this is greater than 1.0, it explains more variance than a single variable, in fact 5.393 times as much. The percentage a variance explained as:-
(5.393/12 unit of variance)(100) = 44.940
Factor II
The 2nd factor has an Eigen Value=2.967. Since this is greater than 1.0, it explains more variance than a single variable, in fact 2.967 times as much. The percentage a variance explained as:-
(2.967/12 unit of variance)(100)= 24.721
Factor III
The 3rd factor has an Eigen Value=2.401. Since this is greater than 1.0, it explained more variance than a single variance, in fact 2.401 times as much. The percent a variance explained as:-
(2.401/12 unit of variance)(100)= 20.012
Result of Table of Communalities and Component matrix
It shows table of communalities before and after extraction. Principal component works on the initial assumption that all variance is common; therefore before extraction all communalities are equal to 1. The communalities in the column labeled extraction reflect the common variance in the data structure. So, for example, we can say that 79.2% of the variance associated with question 1 is common, or shared variance. The component matrix contains the loadings of each variable onto each factor. This matrix is particularly not important for interpretation.
Result of Rotated Component matrix
Table 7:Rotated Component matrix
Components
1
2
3
It helps to promote new products
.970
It helps to attract more customers
.957
If we do not give our compotator will give
.960
Bulk buyer's looks for easy credit
.924
Credit terms make long relations
.920
Marketing people use it to boost the sales
.853
It helps satisfy customer needs better
.966
Credit sale shows firm wants to increase its sales
.917
Its demand of industry to be competitive
.884
To boost sales of a weak product
.920
Customers are limited to the industry
.905
It is not a monopolistic market
.955
The rotated component matrix is a matrix of factor loadings for each variable onto each factor. This matrix contains the same information as the component matrixes expect that it is calculated after rotation. In this matrix factor loadings less than 0.4 are not displayed because we asked to suppress them.
FINDINGS
Interpretation of factors from the rotated component matrix
FACTOR 1: The variables that load highly on factor 1 are-
Variable 2: It helps to attract more customers.
Variable 4: Bulk buyer's looks for easy credit.
Variable 5: Credit terms make long relations.
Variable 7: It helps satisfy customer needs better
These variables relate highly which can be labelled as Increase in Customers.
FACTOR 2: The variables that load highly on factor 2 are-
Variable 3: If we do not give our compotator will give
Variable 9: Its demand of industry to be competitive
Variable 11: Customers are limited to the industry.
Variable 12: It is not a monopolistic market.
These variables relate highly which can be labelled as Industry Demand.
FACTOR 3: The variables that load highly on factor 3 are -
Variable 1: It helps to promote new products.
Variable 6: Marketing people use it to boost the sales.
Variable 8: Credit sale shows firm wants to increase its sales
Variable 10: To boost sales of a weak product.
These variables relate highly which can be labelled as Increase in Sales.
These are the 3 main factors which lead the firm to make credit sales.
Chapter7: Conclusion and Recommendation
Conclusion
The objective of the project is to understand how we can effectively mange the Receivables of the firm
Credit sale is demand of steel pipe industry, the firm needs to grant credit to be competitive and to increase its customers. We can see that the result of research conducted with marketing and finance department of Caparo Tubes India, 75% of people are in favour of having a written credit policy. Credit policy plays a vital in management of receivables.
Credit policy is judged as the major factor for investment in the receivables. Cash discount can be used as a tool for timely collection of receivables.
Factoring is also a simpler option which can help in managing the receivables and also considered that it may help in reducing the percentage of bad debt in the firm. The firm needs to continue with credit sales as this is highly required to be competitive in the industry.
Ageing schedule is used for monitoring the receivables in the firm. Ageing schedule is an easy and effective technique to keep track of receivables which works on the concept how old is the due.
Recommendation
The firm should have a written credit policy which will help the firm to set a standard to allow credit. Credit policy is very important for every firm which allows credit sale.
The company should investigate the credit worthiness of the customers before giving the credit. It may be judged by the financial statements of the customers.
The credit limit for the customers should revise once in a year so that the limit can be as per the current financial condition of the firm.
The Firm should encourage the customers to pay dues in time and cash discount should be used to as a tool to get payments within credit period.
Factoring may be used for the management of receivables.
