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Receivables Management
FREQUENTLY ASKED QUESTION
RECEIVABLES OF MANAGEMENT

Q.1. Write short note on Factoring.
Q.2. Write short note on Factoring vs. Debt Securitization.

Ans. Factoring is an arrangement under which a firm (called borrower) receives advances against its receivables, from a financial institution (called factor). There are many types of factoring, but the general operation a like:
• The borrower sells his Accounts Receivables (i.e. book Debts) to the Factor.
• The factor purchases the receivables and provides advances against them, after deducting and retaining suitable margin, his commission and fees.
• The Borrower forwards collections from his customers to the Factor and settles advances received by him.
• The Factor may also provide allied services like credit investigation, sales ledger management, collection of debts, credit protection and risk bearing.
• In India, factoring is always "with recourse" i.e. in case of default by the customer, the risk of bad debts is borne by the Borrower and the Factor. Non-recourse factoring in not popular.

Conditions : 
Various conditions are laid down for factoring arrangement. Some are:
1 Fixing Credit Limits for each borrower and each customer.
2. Exclusion of certain customers from factoring - for example, sale to sister concerns cannot be factored.
3. Standardization of invoices.
4. Acknowledgement from Customer fro actual supply of goods under the invoice.
5. Instruction to customers that the payments shall be forwarded directly to the financial institution (Factor)

Benefits
a Convertibility: Accounts receivables are easily converted into cash.
b. Definite pattern of cash inflows: Supply invoices are factored immediately. Hence, cash inflows the sale pattern.
c. Reduction in Collection and Administration Costs: There is no need for a separate credit department since credit management may also be undertaken by the factor.
d. Flexibility : The seller firm may continue to finance its receivables continuously, on a more or less automatic basis. If value of sales increase or decrease, it can vary the financing proportionately.
e. Compensating balances are not required in case of factoring, unlike unsecured loans.

Factoring is of two types
a. Non recourse factoring: Here the factor take all the risk. i.e. if there are bad debts Then that is taken up by factor.
b. Recourse factoring: In this type of factoring. The client is non protected against the risk bad debts.

Debt Securitization :
The securitization is an new concept slowly emerging is India. Under securitization of group of illiquid assets say a mortgage or any assets that yield stable and regular cash flows like bank loans consumer finance, credit car payment are poled together and sold to intermediary. The intermediary then issue securities (usually debt instrument) which could be mortgage based security or asset based securities. The securities are required to be credit rated. These securities are than sold to investor through merchant banker. Generally the investor for such securities are institutions like provident fund, pension fund, mutual fund etc. The main advantage of securitization is that profitable if interest rates are going up. The investor also gain once they have a credit rated listed and secured instrument which are further secured by regular cash inflows.

The basic debt securitization process can be classified in the following three function.
1 The origination function : A borrowers seeks a loan from a finance company bank housing company or a lease from a leasing company. The creditworthiness of the borrower is evaluated and a contract is entered into with repayment schedule structured over the life of the loan.
2. The pooling function : similar loans or receivable are clubbed together to create an underlying pool of assets. This pool is transferred in favor of a SPV-(Special purpose vehicle). Which act as a trustee for the investor? Once the assets are transferred, they are held in the originators portfolios.
3. The securitization function : it is the SVP's job now to structure and issue the securities on the basis of the assets pool. The securities carry a coupon and an expected maturity which can be assets based or mortgage based. These are generally sold to investors through merchant banker. The investors interest in this types of securities are generally institutional investors like mutual funds, insurance companies etc. The originator usually keeps the spread available between yield from secured assets and interest paid to investors.
The process of securitization is generally without recourse the investor bears the credit risk or risk of default and the issuer is under an obligation to pay to investor only if the cash flows are received by him from the collateral. The issued however has a right to legal recourse in the event of default. The risk run by the investor can be further reduced through credit enhancement facilities like insurance letter of credit and guarantee.

Benefits to the Originator
1. The assets are shifted off the balance sheet, thus giving the originator recourse to off balance sheet funding.
2. It converts illiquid assets to liquid portfolios.
3. It facilitates better balance sheet management as asset are transferred off balanced sheet facilitating satisfaction of capital adequacy norms.
4. The originator's creditor ratio enhances.

Q.3. Explain the 'Ageing Schedule' in the context of monitoring of receivables. Answer:

Ans. An technique available for monitoring the receivables is known as aging schedule. The quality of the receivables of a firm can be measured by looking at the age of receivables. The older the receivable, the lower is the quality and greater the likelihood of a default. For better control on collection of receivables, a statement analyzing the period of overdue and the amount involved has to be prepared in the following lines illustrated below:
This type of aging schedule can provide a kind of an early warning suggesting (i) deterioration of receivables quality, and (ii) where to emphasize the appropriate corrective actions. When compare with the past aging schedule done by the same firm or done by other comparable firms, this may provide an indication of whether the firm should start worrying about its collection procedure. By comparing the aging schedules for different periods, the financial manager carl get an idea of any required change in the collection procedure and can also point out those customers, which require special attention.

Q.6. Before credit is granted to a customer, a number of factors must be analyzed. Discuss.

Ans. A firm selling on credit terms cannot extend credit to all customers. Credit granting decision is taken on a case-to-case basis, based on the following illustrative factors:

(a) Nature of Product: Generally perishable items are sold on "cash and carry" basis, while durable / non-perishable items may be sold on credit.
(b) Nature of customer: A valued customer, who has long and favourable past dealings with the firm may be given credit immediately, than a new customer. However, credit may also be offered for attracting new customer.
(c) Quantity purchased: Firms may decide to grant credit only beyond a certainlot size. For example, sale upto 5 kg per invoice is made on cash basis only, while orders beyond 5 kg may be supplied on credit.
(d) Value of sale: Sometimes, the invoice value (instead of quantity) may be the determinant in a credit decision. For example, credit may be granted for amounts exceeding Rs.15, 000/-.
(e) Credit worthiness of the customer: The credit-worthiness of the customer is the most crucial factor in deciding whether credit should be granted or not. This is based on past experience (for existing customers) and credit analysis (for existing and new customers).
(f) Risk of Bad Debts: The extent of risk of bad debts that a firm can bear should be determined. For example, if there is a 1% chance of bad debts, the firm may take the risk of credit supply, but when the chance of bad debts is 55%, credit should not be granted.

Credit granting is a two-phase decision making process:
Phase I
Whether Credit should be granted at all? - Decision to be based on Credit Rating.
Phase II
Upto what limits and how credit be granted? - Decision to be based on Cost -Benefit Analysis.

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