Factoring of Accounts Receivables
Factoring of Accounts Receivables is the act of selling the accounts receivables. It involves the purchase of accounts receivables by the lender, generally without recourse to the borrower, which means that if the purchaser of the goods does not pay for them, the lender rather than the seller of the goods takes the loss. Under this arrangement, the buyer of the goods is typically notified of the transfer and is asked to make payments directly to the financial institution, also called the factor.
(Eugene Brigham & Joel Houston; 1998, Fundamentals of Financial Management) Factoring is illustrated as follows: Export Factor On the basis of the so-called Two-Factor system, the export factor is the institution that facilitates the export transaction of the supplier in the supplier’s country. The export factor as an institution provides financing, credit management, sales ledger accounting, or a combination of these services for exporters. (International Factors Group website; www. ifgroup. com/2factor-definition. asp)
Import Factor On the basis of the so-called Two-Factor system, the import factor is the institution that handles credit cover and collection in the buyer’s territory. The import factor as an institution undertakes the debtor credit rating, the collection of payments and if necessary, the legal action against the buyer. Being present in the country of the importer, speaking the same language and understanding the local customs and habits therein, the import factor is in the best position to provide professional and effective services.
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Originally set up in 1926 as an auxiliary organ of the League of Nations and then re-established in 1940 on the basis of a multilateral agreement, is presently an independent intergovernmental organization committed to study the needs and methods for modernizing, harmonizing and coordinating private and, in particular, commercial law as between States and groups of States. (UNIDROIT website) 1988 UNIDROIT Convention on International Factoring – whether or not it has successfully attained its objectives – today continues to relentlessly work for its goal.
Prevailing factors continue to be unaddressed and therefore impede the smooth undertaking of the accounts receivables mechanism in the international scenario. Among such factors is the difference in the languages of the two transacting parties. Such difference causes setbacks in the drafting of sales contracts and other documents. The given fact that the parties come from two different countries further spells out complications. They individually have the receivables financing rules of their respective countries as the basis for the manner that their transaction is going to be processed.
Factoring agents – both the import factor and the export factor – have their own share of complications to deal with. Credit lines may be available for the exporter in his country of origin; it, however, will not be as easy for him to get credit lines from an importer who happens to be in another country. The credit-worthiness of an entity in his native country does not guarantee being accorded the same credit-worthiness in another country.
A similar problem persists regarding the need for an import factor also from the importer’s country to be a willing party to the transaction – there would be difficulty in finding one. At the onset, it is crucial that trust be established among the transacting parties. There would be natural barriers against it, though, like prevailing differences in religion and culture. On top of these complications, there is the exchange rate fluctuation to worry about. The parties will have to come to terms regarding the foreign currency equivalents that their transaction is supposed to be based on.
The transacting parties, both in the course of dealing with an entity from another country, will as well have to take into consideration the legal and business environment in such other country to ensure that they are sufficiently protected and covered from untoward turn of events. On this subject, one question that has to be answered to the satisfaction of all involved would be how debts are settled in the other country in case of the unexpected declaration of bankruptcy by the involved party coming from there.