Page 2 - L9

Limitations

i. Availability of easy and flexible trade credit facilities may induce a firm
to indulge in overtrading, which may add to the risks of the firm;
ii. Only limited amount of funds can be generated through trade credit;
iii. It is generally a costly source of funds as compared to most other
sources of raising money.

Factoring

Factoring is a financial service under which the ‘factor’ renders various services
which includes:

(A)

i. Discounting of bills (with or without recourse) and collection of the
client’s debts. Under this, the receivables on account of sale of goods or
services are sold to the factor at a certain discount.
ii. The factor becomes responsible for all credit control and debt collection
from the buyer and provides protection against any bad debt losses to
the firm.
iii. There are two methods of factoring — recourse and non-recourse.
Under recourse factoring, the client is not protected against the risk of
bad debts.
iv. On the other hand, the factor assumes the entire credit risk under non-
recourse factoring i.e., full amount of invoice is paid to the client in the
event of the debt becoming bad.

(B)

i. Providing information about credit worthiness of prospective client’s
etc., Factors hold large amounts of information about the trading
histories of the firms.
ii. This can be valuable to those who are using factoring services and
can thereby avoid doing business with customers having poor
payment record. Factors may also offer relevant consultancy services
in the areas of finance, marketing, etc.
iii. The factor charges fees for the services rendered. Factoring appeared
on the Indian financial scene only in the early nineties as a result of
RBI initiatives.