inland trade

8/4/2019 Inland Trade

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Domestic Trade and Finance:-

Domestic trade is any commerce that is interacted within a Country. So you buy a bag of rice, thatwas grown, sold and bought all within India, it was all done Domestically.

As opposed to Foreign trade, in which the same bag of rice was perhaps shipped abroad inexchange for some Edam cheese imported from the Netherlands.

Many companies cater to the domestic market because they know applicable laws andregulations the best. There also may be a unique demand for a certain product in the domestic market. Forexample, an American flag supplier will likely sell more flags in the United States than in Canada. Thesize of the domestic market is calculated in the gross domestic product.

In domestic trading, a firm faces only one set of competitive, economic, and market issues andessentially must deal with only one set of customers, although the company may have several segments ina market.

There are certain limitations when competing in a domestic market, many of which encouragefirms to expand abroad. The main reasons why a business would decide to expand abroad is down to alimited market size and limited growth within the domestic market.

Services :-1.Bill Discounting:-

“While discounting a bill, the Bank buys the bill (i.e. Bill of Exchange or PromissoryNote) before it is due and credits the value of the bill after a discount charge to the customer'saccount. The transaction is practically an advance against the security of the bill and the discountrepresents the interest on the advance from the date of purchase of the bill until it is due forpayment. ”

Bill Discounting is a process where the financial institution gets the Bill of Exchange (Cheque / PO /DD etc.) before its maturity date and below its par value. Hence the amount or cash realizedmay vary depending upon the number of days until maturity and the risk involved.

Discounting the bill of exchange is practiced to get the same immediately encashed before thematurity date. The liability in case of dishonor of the bill remains with the person in whose favorthe bill is generated.

A commercial bill discount is an act by which the legal holder of a commercial bill (includingbanker's acceptance draft and commercial acceptance draft) transfers it to bank to acquire cash

before its maturity date.Usually, the Bank may want some conditions to be fulfilled to be able to discount a bill:

A bill must be a usance bill

It must have been accepted and bear at least two good signatures (e.g. of reputable individuals,companies or banks etc.)



The Bank will normally only discount trade bills

Where a usance bill is drawn at a fixed period after sight, the bill must be accepted to establishthe maturity

The advising or confirming bank will hide the reimbursement instruction from the beneficiary so thathis bank must present the documents to the nominated bank for negotiation in order to obtain paymentunder the DC terms.

Bills which are financed by the receiving branch, whether drawn under a DC or not, are treated asBills Receivable by both the remitting branch and the receiving branches.

Bill Discounting: Documents

The borrower and/or the guarantors have to provide the following documents to the banks or thelending institutions while submitting Bill Discounting Application. Certain documents may be demandedby the bank or the lending institutions in post sanction phase or on periodical basis

Address Proof : Latest Electricity/Telephone Bill or Receipt of Maintenance Charges or ValidPassport or Voter‟s Identity Card or Purchase/L ease Deed/ Leave & License Agreement of Residence or Office Premises.

Identity Proof : Valid Passport, PAN Card, Voter‟s Card, Any other photo identification issued byGovernment Agencies.

Business Proof : VAT/CST Registration No. or MIDC Agreement or SSI Permanent RegistrationCertificate or Warehouse Receipts or Shop & Establishment Act Certificate or Copy of LeaseAgreement along with the latest Rent paid Receipt.

Business Profile on Company‟s Letterhead.

Partnership deed in case of partnership firms.

Certificate of incorporation, Date of Commencement of Business and Memorandum of TitleDeeds, Form 32 in for Addition or Deletion of Directors in case of companies.

Last three years Trading, Profit & Loss A/c. and Balance Sheets (duly signed by a CharteredAccountant wherever applicable)

Last one years‟ Bank statement of the Firm.

If existing loan, then sanctioning letter and repayment schedule of the same.

Firm/Company‟s PAN Cards.

Individual Income Tax Returns of the Individual/Partners/Directors for last three years.

Last one years‟ Bank statement of Individuals, Partners, Directors.

SEBI formalities in case of listed companies.



Share Holding pattern of Directors duly certified by a Chartered Accountant.

List of the Existing Directors of the company from the Registrar of the Companies.

Written & approved confirmation of having No Legal Suit filed against any of the directors. If any such legal suit or proceedings are pending then the details of such legal suit or proceeding.

Presenting a bill

Bills may be presented to the nominated bank in two ways:

1. With recourseThe Bank checks the documents and confirms that they comply with the DC terms, and send thebill with the original DC to the nominated bank requesting payment. The nominated bank neednot recheck the documents and it can claim a refund from us in the case of an unspotteddiscrepancy. We pay our customer after receipt of funds from the nominated bank.

2. Without recourseThe Bank passes the original DC and unchecked documents to the nominated bank on acollection basis, requesting payment. The nominated bank has to check the documents in thenormal way. Usually, we present documents to the nominated bank without recourse:

a. When the opening bank is a member of the Bank nominated for payment, acceptance ornegotiation

b. When the nominated bank has confirmed the DC

c. When the nominated bank is the drawee.If you have a good standing, the bank can give you an advance against an OBN bill. You will

then have to repay the advance from the proceeds of the bill.

Bill Discounting: Process

The following are the sequence of steps taken by the banks on receipt of completed application forms.

1. Sellers sign the financing agreement with his Remitting Bank, and submit the export documents.2. After approving the documents, Remitting Bank mails them to the issuing bank or a designated

bank for reimbursement.

3. Upon receipt of the documents, the issuing bank will give the instruction of acceptance.4. Upon receipt of acceptance order, the customers should submit business application to RemittingBank, and Remitting Bank effects the payment to the seller.

5. Issuing bank effects payment at maturity, which Remitting Bank will use it to cover the discountpayment.



Disbursement of the loan takes place after the Legal Dept. Certifies the Correctness of executiondocuments.

2. Letter of Credit: Overview

Letter of credit is an instrument or a letter of comfort issued by the Buyer‟s bank on behalf of buyer for the benefit of the seller. This letter guarantees the payment to the seller so that theseller canmanufacture and supply the goods or provide the services to the buyer without any inhibitions.The seller has to ensure that the all the terms and conditions of the Letter of Credit (LC) is strictlyfollowed. The seller presents the Letter of Credit and raises money from his bank to meet the workingcapital requirements viz. purchase of raw materials, payment of wages, manufacturing expenses etc. Aftermanufacture, the goods (as per specifications mentioned in the Letter of credit) are shipped to thedestination as required by the buyer. The shipping documents along with all the other documents arepresented by the seller to his banker and theamount of pre shipment loan/facility is settled andthe balance is realized by the seller.

This instrument or method is often used in Selling, Buying or Service Providing contracts acrosscountries and / or where both the parties have no established business relationships.

L/C are used, although not as frequently, because shipping times are shorter and companies morefrequently know each other or can get credit references, and they can use domestic courts if the deal goesbad.

Most domestic letters of credit are "stand-by" letters used as a guarantee for the availability of funds or a guarantee of job completion.

provides cover to the seller against



– Credit risk of the buyer

– Contract disputes

– Currency inconvertibility

– Government legislation

Key Points:-

• An LC, also referred to as a documentary credit, is a contractual agreement whereby a bank inthe buyer‟s country, known as the issuing bank, acting on behalf of its customer (the buyer or importer),authorizes a bank in the seller‟s country, known as th e advising bank, to make payment to the beneficiary(the seller or exporter) against the receipt of stipulated documents.

• The LC is a separate contract from the sales contract on which it is based and, therefore, thebank is not concerned whether each party fulfills the terms of the sales contract.

• The bank‟s obligation to pay is solely conditional upon the seller‟s compliance with the termsand conditions of the LC. In LC transactions, banks deal in documents only, not goods.

Characteristics of a Letter of Credit:-

Applicability



Recommended for use in new or less-established trade relationships when you are satisfied withthe creditworthiness of the buyer‟s bank.

Risk

Risk is evenly spread between seller and buyer provided all terms and conditions are adhered to.

Pros

• Payment after shipment

• A variety of payment, financing and risk mitigation options

Cons

• Process is complex and labor intensive

• Relatively expensive in terms of transaction costs

Illustrative Letter of Credit Transaction :-

1. The buyer arranges for the issuing bank to open an LC in favor of the seller.2. The issuing bank transmits the LC to the advising bank, which forwards it to the seller.3. The seller forwards the goods and documents to a freight forwarder.4. The freight forwarder dispatches the goods and submits documents to the advising bank.5. The advising bank checks documents for compliance with the LC and pays the seller.6. The buyer ‟s account at the issuing bank is debited. 7. The issuing bank releases documents to the buyer to claim the goods from the carrier.

Stand-By Letter of Credit:-

What is a standby letter of credit?

A Standby Letter of Credit (called “SLC or “LC”) are written obligations of an issuing bank topay a sum of money to a beneficiary on behalf of their customer in the event that the customer does notpay the beneficiary. It is important to note that standby letters of credit apply only whenever the issuingbank's commitment to pay is not contingent on the existence, validity and enforceability of its customer‟sobligation; this is called an “abstract” guarantee; that is, the bank‟s obligation is to pay regardless of anydisputes between its customer and the beneficiary. The issuance of letters of credit is a private transactionand does not result in the issuance of any public trading securities.

Standby LC is no different from a bank guarantee. The only difference is that a standby LCcomes under the UCP and ISP98 (ICC Publication), BGs don't have such cover.

Why do we have standby letters of credit?

The standby letter of credit comes from the banking legislation of the United States, whichforbids US credit institutions from assuming guarantee obligations of third parties. (Most other countries



outside of the USA continue to allow bank guarantees.) To circumvent this US banking rule, the USbanks created the standby letter of credit, which is based on the uniform customs and practice fordocumentary credits. In 1998 the International Chamber of Commerce (ICC) added ISP98 (InternationalStandby Practices 98) as the rules to guide standby letters of credit. These rules are slowly being adopted;however, many of the standby letters of credit conti nue to rely on the ICC‟s older guide, Uniform

Customs and Practices for Documentary Credits, 1993 revision, ICC Publication 500.

Who are the parties to the standby letter of credit?

(1) The Applicant. This is the customer of the bank who applies to the bank for the standby letterof credit. He must provide collateral to the bank or have sufficient credit to induce the bank to issue theinstrument. He also must pay the bank a fee for issuing the instrument.

(2) The Issuing Bank. This is the ap plicant‟s bank that issues the standby letter of credit.

(3) The Beneficiary. This is the party in whose favor the instrument is issued.

(4) Confirming Bank. This is a bank (usually located near the beneficiary) that agrees (confirms)to pay the beneficiary rather than have the issuing bank pay the beneficiary. The beneficiary pays theConfirming Bank a fee for this convenience. The Confirming Bank then collects from the Issuing Bank the amount paid to the beneficiary.

(5) Advising Bank. This is the bank that represents the beneficiary. It may accept the letter of credit on behalf of the beneficiary and collect on it on behalf of the beneficiary. In order for thetransaction to be a bank-to-bank transaction, the advising bank works for the beneficiary to keep theinstrument in the banking system. Sometimes the Advising

Bank also is the Confirming Bank, but not always.

What is the purpose of the standby letter of credit?

The standby basically fulfills the same purpose as a bank guarantee: it is payable upon firstdemand and without objections or defenses on the basis of the underlying transaction between theapplicant and the beneficiary. It is up to the beneficiary to decide whether he may accept a standby.

What are the types of standby letters of credit?

(1) Performance Standby. This instrument supports an obligation to perform other than to pay

money including the purpose of covering losses arising from a default of the applicant in completion of the underlying transaction.

(2) Advance Payment Standby. This instrument supports an obligation to account for an advancepayment made by the beneficiary to the applicant.

(3) Bid Bond/Tender Standby. This standby supports an obligation of the applicant to execute acontract if the applicant is awarded a bid.



(4) Counter Standby. This instrument supports the issuance of a separate standby or otherundertaking by the beneficiary of the counter standby.

(5) Direct Pay Standby. This instrument serves to support payment when due of an underlyingpayment obligation typically in connection with a financial standby without regard to default. Thisstandby is also used to directly pay an obligation where the only conditions of payment are the passage of the term and presentment of payment.

(6) Insurance Standby. This instrument is an insurance or reinsurance obligation of the applicant.

(7) Commercial Standby. This is the most used standby and it supports the obligations of anapplicant to pay for goods or services in the event of non-payment by a business debtor.

Are standby letter of credits transferable?

Assignment of Standby letter of credit proceeds -The beneficiary can assign the proceeds of astandby letter of credit. But this assignment does not assign the rights of the beneficiary as “drawer” on

the standby letter of credit, and only the beneficiary may exercise the “drawer” right s and present thedemand for payment under the terms of the standby letter of credit unless the terms of the instrumentprovide otherwise. This means that the assignee may receive the proceeds of the standby, but in order toobtain those proceeds the beneficiary must first make the demand for payment. This also means that thebeneficiary can sell by assignment, at discount, the benefits of the standby. An assignment of proceedsrequires notice to the issuing bank of this action; otherwise the issuing bank would pay the beneficiaryrather than the assignee.

Transfer of Standby letter of credits. Standby letter of credits can be transferred to a third partyONLY with the written consent of the issuing bank AND the beneficiary.

Are standby letter of credits the subject of trading?

There is no public market for the trading of standby letters of credits. Standby letters of creditscan only be transferred or the proceeds assigned in private transactions (as previously noted above).

Standby letters of credit do not have CUSIP or ISIN numbering.

Standby letters of credits are not trading securities, trading debt instruments, or tradinginvestment funds, and therefore are not subject to the rules and regulations of the Security and Exchange

Commission.

Advantages:-

It can be used to cover different types of contracts Can guarantee the seller ‟s performance in some transactions or only in one specific

transaction (such as capital goods‟ import with technical specifications, projects on a turn -keybasis, etc.)

Could cover the compliance of the buyer in open account for a number of transactions.



Is usually required in international biddings.

Costs:-

Issuing fee and amendments for term and/or amount: a percentage of the total amount for thetotal term; generally this fee is expressed on a per annum basis.

Other costs: amendment, cable, etc.

3.Financial Guarantee: Overview

A bank guarantee is an undertaking by the bank to pay a sum of money to the beneficiary againstpresentation of a written demand and any other documents specified in the guarantee

It is IRREVOCABLE i.e. cannot be cancelled before the expiry date unless the original guaranteeis returned to the bank duly discharged by the beneficiary

Features :-

Guarantor undertakes, that in the event of default by the principal, to make payment Amount is fixed Expiry date is fixed Against a claim from beneficiary Guarantees are generally governed by Beneficiary country Law or URDG 458

Non funded facility A form of indirect „finance‟; Known as „trade facilitators‟

Benefits:-

Benefits to the Bank

• Commission Income



• Cross selling opportunity

Benefits to the Principal

• Better liquidity management

• Cost effective

Benefits to the Beneficiary• Certainty of payment• Bank risk Vs Principal risk- Profile better

Common Classification:-• Direct Guarantee

Issued directly to the beneficiary by a Bank Issued directly to the beneficiary however sent through an advising Bank

Indirect GuaranteeIssued to the correspondent Bank, requesting them to issue a guarantee directly to the

beneficiary.• Financial / Non financial

How to determine if a Guarantee is a financial or a non-financial Guarantee?- Identify the trigger event in a Guarantee- A trigger event of a Guarantee is the event which leads to invocation (calling) of the

Guarantee.- If the trigger event is non-payment, the Guarantee is a financial Guarantee.- If the trigger event is non-financial, the Guarantee is a non-financial Guarantee

• On-DemandPayable on receipt of a written demand from the beneficiary

On – DefaultAutomatically payable on default by the applicant

• ConditionalPayable on fulfilment of certain conditions, in the form of certain documents, as specifiedin the guaranteeE.g. Submission of:

An expert opinion in the form of an Inspection Certificate from an independentauthority, or

An arbitral / adjudication awardUnconditional

The beneficiary has the right to claim the amount guaranteed without submission of anyadditional / supporting documents

Most of the Beneficiaries and Banks prefer issuance of unconditional demand bonds Trade Related

Non-cancelable indemnity bond, guaranteeing the timely payment of principal andinterest by a maturity date.

Mostly Credit Substitute Guarantees issued by the reporting entity to secure a creditfacility granted by a third party to another party.Non Trade related

An undertaking by the bank (guarantor),- to pay a certain sum of money,- to the beneficiary,- if the bank's customer defaults,



- on its trade-related contractual obligationsAlso known as Non Credit Substitute Guarantees

Trade Related Guarantee Types:-- Bid bond

E.g. Government tender for construction of building

BANKGUARANTOR

CONTRACTORGOVERNMENT

In case of default…

Trigger: Non-performance –

Unable to take up the tender

TENDER +

BID BOND GUARANTEE

REQUEST FORISSUANCE

GUARANTEE

CLAIM

PAYMENT

- Performance bond

E.g. Contract for construction on building within a scheduled date

PARTY 1(REQUIRES BUILDING)

PARTY 2CONTRACTOR

BANKGUARANTOR

CONTRACT

REQUEST FORISSUANCE

GUARANTEE


CLAIM

PAYMENT

Trigger: Non-performanceUnable to complete building



– Advance payment Guarantee & Stage Payment Guarantee

E.g. Advance & Stage payments for supply of goods

BUYER

BANKGUARANTOR

CONTRACT

REQUEST FORISSUANCE

GUARANTEE


CLAIM

PAYMENT

Trigger: Non-performanceUnable to supply goods

SUPPLIERADVANCE / STAGEPAYMENT

Application criteria:-

(1) Meet the basic criteria for working capital loans required by RBI;

(2) Has a corresponding scope of business operations;

(3) Can provide the required counter guarantee, and for foreign-invested enterprises (equity jointventure, cooperative joint venture, foreign wholly-owned enterprise), they have to provide documents oncounter guarantee in relation to implementation of the requirements on the investment ratio from thedomestic and foreign parties;

(4) Guarantees for basic infrastructure and technology improvement projects must fulfill RBI ‟s criteriafor project loans;

(5) Guarantee applications for overseas creditors must comply with the state‟s foreign exchangeregulations.

Financial Guarantee: Process

The following are the sequence of steps taken by the banks on receipt of completed application forms.

1. Application form is accepted and acknowledged.

2. Personal interview /discussions is held with the customers by the bank‟s officials.



3. Bank's Field Investigation team visits the business place/work place of the applicant.(All the documents submitted are verified by the bank with the originals so as to ensure theauthenticity of the same.)

4. Bank verifies the track record of the applicant with the common information sharing bureau(CIBIL).

5. In case of fresh projects the bank analyses the back ground of the applicant/firm/company and theTechnical feasibility/financial viability of the project based on various parameters and also theexisting market conditions.

6. Depending on the size of the project the file is put up for sanction to the appropriate level of authority.

Guarantee Workflow

BUYER SELLER

GUARANTOR

Contract

Agreement between the Buyerand Seller Application

The Applicant (Seller) submitsthe Application, Indemnity and

Text of the Guarantee to theGuarantee Issuing Bank

(Guarantor)

Guarantee

Guarantee

The Guarantee is issued to theApplicant wh ich is subsequently

forwarded to the Applicant

Direct: Issued directlyto Beneficiary

ADVISING BK

The Guarantee issued is advisedto the Applicant by his bankers.

Direct: Advisedthrough bank

Guarantee

GuaranteeGUARANTOR

Indirect: Guaranteebased on counter-

guarantee

Counter-Guarantee

Counter guarantee is a guaranteewhich a receiver gives to onewho gives him a guarantee,

reciprocal guarantee

Criteria for Issuance

- Bank guarantees should be issued only for the customers who have credit limits with the bank - The customer should give an application and sign a counter indemnity. This indemnity can be

individual or blanket- The guarantee text should be acceptable to the bank

Instructions for Issuance of Guarantees

All such instructions must in brief, clear and precise terms stipulate:

1. The Principal2. The Beneficiary



3. The Guarantor4. The underlying transaction5. Maximum amount payable and currency of payment6. The Expiry Date and /or Expiry Event of the Guarantee7. The terms for demanding payment

8. Any provision for reduction in the guarantee amount

Expiry of Guarantee:-

A guarantee expires on the happening of:

1. “Expiry Date ”:

the period of validity has ended

2. “Expiry Event ”:

- The occurrence of any “Specific Event” stipulated in the Guarantee (Submission of Transport Documents in Shipping Guarantees)

- The guarantee is returned for cancellation- The bank is released from its obligations- The entire amount of the guarantee is paid by the bank

Open Ended / Perpetual Guarantees:-

- These are the guarantees with no expiry date i.e. the guarantee will be valid till the originalguarantee is returned to the bank duly discharged by the beneficiary

- This can be issued only with the specific approval from the appropriate authorities

Claims:-

1. If you are the beneficiary of a Bank Guarantee …

• How do you submit the claim?

• Remember the expiry date!

• Claim needs to be in accordance with the wording of the Guarantee.

• When in doubt; CLAIM! A claim will constitute your rights and can be withdrawn.

2. If You are the applicant of a Bank Guarantee:

• The Bank is not obliged to notify. However as a service they may inform you about a claim

• The Bank will determine whether or not the claim is in accordance with the wording of theGuarantee. It will not determine „who is right‟.

• The Bank will fulfil its obligations resulting from the Guarantee, independently.

3. If you are the Guarantor- Should be received by the bank within the expiry / claim expiry of the guarantee- The wording of the claim should be as per the terms of the guarantee- It should be supported by the documentation specified in the guarantee, if any



- The claim must be authentic- If it is a pure claim, the guarantee / claimed amount should be paid to the beneficiary immediately- In case of an extension claim, the claim should be registered and request to be sent to the

applicant for extension of guarantee

Cancellation:-

- All Guarantees and Counter-guarantees are irrevocable unless otherwise stated- All parties to an irrevocable guarantee must agree to its Cancellation OR Amendment- For cancellation Beneficiary must present the following to the Guarantor (Irrespective of any

expiry provision contained therein) :

1. A request letter from the Applicant for cancellation of the Guarantee

2. Beneficiary‟s Discharge Letter or written statement of release of Guarantor‟s liability

3. (Return of ) the original guarantee with all amendments (in original)

Sanction AND Disbursement:

1. On approval/sanction, the sanction letter, is issued specifying the terms and conditions for thedisbursement of the loan. The acceptance to the terms of sanction is taken From the Applicant.

2. The processing charges as specified by the bank have to be paid to proceed further with thedisbursement procedure.

3. The documentation procedure takes place viz.Legal opinion of various property documents andalso the valuation reports.(Original Documents to title of the immovable assets are to besubmitted)

4. All the necessary documents as specified by the legal dept., according to the terms of sanction of the loan of the bank are executed.

4.Factoring Services :-

Factoring is a financial transaction whereby a business job sells its accounts receivable(i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate moneywith which to finance continued business. Factoring differs from a bank loan in three main ways.First, the emphasis is on the value of the receivables (essentially a financial asset ), not the firm‟scredit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (thereceivable). Finally, a bank loan involves two parties whereas factoring involves three.

It is different from forfaiting only in the sense that forfaiting is a transaction-basedoperation involving seller in which the firm sells one of its transactions, while factoring is aFinancial Transaction that involves the Sale of any portion of the firm's Receivables.

Factoring is a word often misused synonymously with invoice discounting - factoring isthe sale of receivables, whereas invoice discounting is borrowing where the receivable is used ascollateral.



The three parties directly involved are:1. the one who sells the receivable,2. the debtor, and3. the factor.

The receivable is essentially a financial asset associated with the debtor's liability to pay

money owed to the seller (usually for work performed or goods sold). The seller thensells one or more of its invoices (the receivables) at a discount to the third party, thespecialized financial organization (aka the factor), to obtain cash. The sale of thereceivables essentially transfers ownership of the receivables to the factor, indicating thefactor obtains all of the rights and risks associated with the receivables. Accordingly, thefactor obtains the right to receive the payments made by the debtor for the invoiceamount and must bear the loss if the debtor does not pay the invoice amount. Usually, theaccount debtor is notified of the sale of the receivable, and the factor bills the debtor andmakes all collections. Critical to the factoring transaction, the seller should never collectthe payments made by the account debtor, otherwise the seller could potentially risk further advances from the factor.

There are three principal parts to the factoring transaction;a.) the advance, a percentage of the invoice face value that is paid to the seller

upon submission,b.) the reserve, the remainder of the total invoice amount held until the payment

by the account debtor is made andc.) the fee, the cost associated with the transaction which is deducted from the

reserve prior to it being paid back the seller.

Sometimes the factor charges the seller a service charge, as well as interest based on how

long the factor must wait to receive payments from the debtor. The factor also estimates theamount that may not be collected due to non-payment, and makes accommodation for this whendetermining the amount that will be given to the seller. The factor's overall profit is thedifference between the price it paid for the invoice and the money received from the debtor, lessthe amount lost due to non-payment.

In the United States, under the Generally Accepted Accounting Principles receivables areconsidered sold when the buyer has "no recourse," or when the financial transaction issubstantially a transfer of all of the rights associated with the receivables and the seller'smonetary liability under any "recourse" provision is well established at the time of the sale.

Otherwise, the financial transaction is treated as a loan , with the receivables used as collateral

To customers, factoring makes possible:

An easier and faster access to operating funds that can be used to:a) speed up their turnover of goods and services,b) pay obligations towards suppliers in a timely manner,a) use discounts, rebates and similar,



b) increase current liquidity,c) Improve their money flow.

To improve the company balance sheet and to improve creditworthiness' and borrowingcapabilities.

Apart from the above mentioned, as a new creditor the Bank possesses long standing experienceand will gladly satisfy your wishes.

Factoring is granted on terms of up to and above 3 months.

The factoring discount rate is established in accordance with Bank‟s Decision on Interest Rates.

Differences from bank loans:-

Factors make funds available, even when banks would not do so, because factors focusfirst on the credit worthiness of the debtor, the party who is obligated to pay the invoices for

goods or services delivered by the seller. In contrast, the fundamental emphasis in a bank lendingrelationship is on the creditworthiness of the borrower, not that of its customers. While bank lending is cheaper than factoring, the key terms and conditions under which the small firm mustoperate differ significantly.

From a combined cost and availability of funds and services perspective, factoringcreates wealth for some but not all small businesses. For small businesses, their choice is slowingtheir growth or the use of external funds beyond the banks. In choosing to use external funds

beyond the banks the rapidly growing firm‟s choice is between seeking venture capital (i.e.,equity) or the lower cost of selling invoices to finance their growth. The latter is also easier to

access and can be obtained in a matter of a week or two, whereas securing funds from venturecapitalists can typically take up to six months. Factoring is also used as bridge financing whilethe firm pursues venture capital and in conjunction with venture capital to provide a loweraverage cost of funds than equity financing alone. Of course one needs to note that Equity capitalhas the highest cost in the long run, as a firm needs to demonstrate higher return on investmentfor its shareholders Firms can also combine the three types of financing, angel/venture, factoringand bank line of credit to further reduce their total cost of funds whilst at the same timeimproving cash flow.

As with any technique, factoring solves some problems but not all. Businesses with a

small spread between the revenue from a sale and the cost of a sale, should limit their use of factoring to sales above their breakeven sales level where the revenue less the direct cost of thesale plus the cost of factoring is positive.

While factoring is an attractive alternative to raising equity for small innovative fast-growing firms, the same financial technique can be used to turn around a fundamentally goodbusiness whose management has encountered a perfect storm or made significant businessmistakes which have made it impossible for the firm to work within the constraints of their bank



covenants. The value of using factoring for this purpose is that it provides management time toimplement the changes required to turn the business around. The firm is paying to have theoption of a future the owner‟s control. The association of factoring with troubled situationsaccounts for the half-truth of it being labeled 'last resort' financing. However, use of thetechnique when there is only a modest spread between the revenue from a sale and its cost is notadvisable for turnarounds. Nor are turnarounds usually able to recreate wealth for the owners inthis situation.

Large firms use the technique without any negative connotations to show cash on theirbalance sheet rather than an account receivable entry, money owed from their customers,particularly when these show payments being due for extended periods of time beyond the NorthAmerican norm of 60 days or less.

Invoice sellers:-

The invoice seller presents recently generated invoices to the factor in exchange for an amountthat is less than the value of the invoice(s) by an agreed upon discount and a reserve. A reserve is aprovision to cover short payments, payment of less than the full amount of the invoice by the debtor, or apayment received later than expected. The result is an initial payment followed by a second one equal tothe amount of the reserve if the invoice is paid in full and on time or a credit to the account of the sellerwith the factor. In an ongoing relationship the invoice seller will get their funds one or two days after thefactor receives the invoices. Astute invoice sellers can use a combination of techniques to cover the rangeof 1% to 5% plus cost of factoring for invoices paid within 50 to 60 days or more. In many industries,customers expect to pay a few percentage points higher to get flexible sales terms. In effect the customeris willing to pay the supplier to be their bank and reduce the equity the customer needs to run theirbusiness. To counter this it is a widespread practice to offer a prompt payment discount on the invoice.

This is commonly set out on an invoice as an offer of a 2% discount for payment in ten days. {Few firmscan be relied upon to systematically take the discount, particularly for low value invoices - under$100,000 - so cash inflow estimates are highly variable and thus not a reliable basis upon which to makecommitments.} Invoice sellers can also seek a cash discount from a supplier of 2 % up to 10% (dependingon the industry standard) in return for prompt payment. Large firms also use the technique of factoring atthe end of reporting periods to „dress‟ their balance sheet by showing cash instead of accounts receivable.There are a number of varieties of factoring arrangements offered to invoice sellers depending upon theirspecific requirements. The basic ones are described under the heading Factors below.

Factors:-

When initially contacted by a prospective invoice seller, the factor first establisheswhether or not a basic condition exists, does the potential debtor(s) have a history of paying theirbills on time? That is, are they creditworthy? (A factor may actually obtain insurance against thedebtor‟s becoming bankrupt and thus the invoice not being paid.) Th e factor is willing toconsider purchasing invoices from all the invoice seller‟s creditworthy debtors. The classicarrangement which suits most small firms, particularly new ones, is full service factoring wherethe debtor is notified to pay the factor (notification) who also takes responsibility for collection



of payments from the debtor and the risk of the debtor not paying in the event the debtorbecomes insolvent, non-recourse factoring. This traditional method of factoring puts the risk of non-payment fully on the factor. If the debtor cannot pay the invoice due to insolvency, it is thefactor's problem to deal with and the factor cannot seek payment from the seller. The factor willonly purchase solid credit worthy invoices and often turns away average credit qualitycustomers. The cost is typically higher with this factoring process because the factor assumes agreater risk and provides credit checking and payment collection services as part of the overallpackage. For firms with formal management structures such as a Board of Directors (withoutside members), and a Controller (with a professional designation), debtors may not benotified (i.e., non-notification factoring). The invoice seller may not retain the credit controlfunction. If they do then it is likely that the factor will insist on recourse against the seller if theinvoice is not paid after an agreed upon elapse of time, typically 60 or 90 days. In the event of non-payment by the customer, the seller must buy back the invoice with another credit worthyinvoice. Recourse factoring is typically the lowest cost for the seller because they retain the bad

debt risk, which makes the arrangement less risky for the factor.Despite the fact that most large organizations have in place processes to deal with

suppliers who use third party financing arrangements incorporating direct contact with them,many entrepreneurs remain very concerned about notification of their clients. It is a part of theinvoice selling process that benefits from salesmanship on the part of the factor and their client inits conduct. Even so, in some industries there is a perception that a business that factors its debtsis in financial distress.

There are two methods of factoring: recourse and non-recourse. Under recourse factoring, theclient is not protected against the risk of bad debts. On the other hand, the factor assumes theentire credit risk under non-recourse factoring i.e., full amount of invoice is paid to the client inthe event of the debt becoming bad.

Invoice payers (debtors):-

Large firms and organizations such as governments usually have specialized processes todeal with one aspect of factoring, redirection of payment to the factor following receipt of notification from the third party (i.e., the factor) to whom they will make the payment. Many butnot all in such organizations are knowledgeable about the use of factoring by small firms andclearly distinguish between its use by small rapidly growing firms and turnarounds.

Distinguishing between assignment of the responsibility to perform the work and theassignment of funds to the factor is central to the customer/debtor‟s processes. Firms havepurchased from a supplier for a reason and thus insist on that firm fulfilling the work commitment. Once the work has been performed however, it is a matter of indifference who ispaid. For example, General Electric has clear processes to be followed which distinguishbetween their work and payment sensitivities. Contracts direct with US Government require an



Assignment of Claims which is an amendment to the contract allowing for payments to thirdparties (factors).



Advantages:-

Immediate cash - up to 90% of the value of assigned invoices can be available to you within 48hours of our receipt of the invoices.

Payment collection - we assume payment collection responsibility for assigned receivables. Protection against customer insolvency - if your customers are unable to pay due to insolvency,

we will reimburse you up to the full amount of the outstanding assigned invoices. Complete statistics - at your request, we will provide you with a weekly or monthly analysis of

sales and payable invoices as well as reports on customer payments. Flexible financing - because our finance is based on your sales, your financing can grow with us

as your sales increase.

No other collateral is required - when we provide you with finance, we ask for no additionalcollateral. Receivables assigned to us are our only guarantees.

Payment guarantees:-

The Factoring Agreement can be signed between the seller and VUB Factoring:

Without recourse (without recourse to the seller) - the factor (VUB Factoring) assumes the risk of non-payment of invoices due to customer insolvency,

With recourse (with recourse to the seller) - the factor does not assume any risk of non-paymentof the invoice and the seller is responsible for bad debts. The seller is also obliged to repay theadvance payment to the factor if the buyer fails to pay.

Costs :-

The costs consist of two elements:

factoring fee, Interest rate.



Factoring fee - includes the administrative handling of your invoices and the guarantee against customerinsolvency. It is based on the following criteria:

degree of customer insolvency risk, total factored turnover, the number of assigned invoices and their average value, the value of claims issued.

Interest rate - is similar to the short-term credit rate set by commercial banks. However, it is calculatedonly on the basis of actual funding used.

Risks:-

The most important risks of a factor are:

Counter party credit risk related to clients and risk covered debtors. Risk covered debtors can be

reinsured, which limit the risks of a factor. Trade receivables are a fairly low risk asset due to theirshort duration.

External fraud by clients: fake invoicing, mis-directed payments, pre-invoicing, not assigned creditnotes, etc. A fraud insurance policy and subjecting the client to audit could limit the risks.

Legal, compliance and tax risks: large number of applicable laws and regulations in differentcountries.

Operational risks, such as contractual disputes. Uniform Commercial Code (UCC-1) securing rights to assets. IRS liens associated with payroll taxes etc. ICT risks: complicated, integrated factoring system, extensive data exchange with client.

5.Forfaiting:-

“The purchasing of a seller's receivables (the amount buyers owe the seller) at a discount by

paying cash. The forfaiter, the purchaser of the receivables, becomes the entity to whom the buyer is

obliged to pay its debt ”.

By purchasing these receivables - which are usually guaranteed by the buyer's bank - the forfaiter

frees the seller from credit and from the risk of not receiving payment from the buyer who purchased the

goods on credit. While giving the seller a cash payment, forfaiting allows the buyer to buy goods for

which it cannot immediately pay in full. The receivables, becoming a form of debt instrument that can be

sold on the secondary market, are represented by bills of exchange or promissory notes, which are

unconditional and easily transferred debt instruments.

Characteristics :-

The characteristics of a forfaiting transaction are:

Credit is extended to the seller for a period ranging between 180 days to seven years.



Minimum bill size is normally US$ 250,000, although $500,000 is preferred.

The payment is normally receivable in any major convertible currency.

A letter of credit or a guarantee is made by a bank, usually in the buyer's country.

The contract can be for either goods or for services.

At its simplest the receivables should be evidenced by

a promissory note, a bill of exchange, a deferred-payment letter of credit, or a letter of guarantee.

Three elements relate to the pricing of a forfaiting transaction:

Discount rate, the interest element, usually quoted as a margin over LIBOR.

Days of grace, added to the actual number of days until maturity for the purpose of coveringthe number of days normally experienced in the transfer of payment, applicable to the countryof risk.

Commitment fee, applied from the date the forfeiter is committed to undertake the financing,until the date of discounting.

For a long time forfaiters established as a prerequisite for a book receivable to be forfaited that itwas represented by a bill of international format (promissory note or bill of exchange) duly subscribed bythe debtor and guaranteed by his banker. Only recently has the forfaiting market gradually enlarged to

cover maturities longer than five years and shorter than six months. Up to a few years ago this would havebeen considered as operating limits.

As a result of that, forfaiting can also now be used as an alternative to the advising bank‟sconfirmation provided that the letter of credit (LC) beneficiary obtains, soon after its notification, acommitment from a reliable forfaiting house to discount the LC proceeds on a without-recourse basis.

Even in the case of a sight LC forfaiters do intervene issuing „silent confirmations‟ in favour of th e LCbeneficiary when the advising bank does not add its confirmation either because the risk involved is toohigh or because the issuing bank does not allow it.

Forfaiting will expand rapidly in the whole short-term area and the reason for that relies on the following:

The short-term potential market is very big if compared to the long-term one, whose size islimited to a few kinds of goods such as machinery, equipment and turnkey plants.

The use up to now of forfaiting in that area has been only marginal since many exportingcompanies did not feel it as a real need



Clearing the books Most people are still used to keeping short-term receivables and to collecting them at their

maturity but I expect this policy will change in the near future because all companies doing so show anegative impact on their balance sheet, i.e. a large exposure in receivables from sales in one side and ahigh level in debts towards banks in the other.

The only way for those companies to improve their balance sheet is a greater use of forfaiting. In fact, theuse of this instrument gives all exporting houses a lot of benefits and specifically allows them to:

Make free all the capital invested in receivables and employ it to grow and to develop business;

Reduce the indebtedness towards banks thus saving interest costs and improving ROI index;

Avoid delays on collection or eventual losses on book receivables due to political and commercialrisk.

In fact forfaiting does not limit its effect on solving liquidity squeeze problems, but it gets the exportingcompanies free from all risks connected with the payment of receivables at their respective maturity. It istherefore wrong to compare the cost of forfaiting to the cost of other types of financing as many peopledo.

In this regard it is advisable to emphasise once again that:

Forfaiting is not at all a financing but a purchase-sale of credit instruments (e.g., bills, promissorynotes, book receivables, etc).

The discount rate applied in a forfaiting contract does not identify interest payable in advance and

as such deductible from the face value but the parameter to be used to calculate the purchase priceof a bill or a book receivable, based on its present value;

The net proceeds of a forfaiting transaction is effectively the price paid by a forfaiter to becomethe new beneficiary of the payment obligation he has purchased.

Let us talk now about the modalities to follow when you want to sell a book receivable on theforfaiting market. As a rule forfaiters ask for bills guaranteed by a domestic bank in the importing countrythrough an aval or a separate letter of guarantee or a documentary credit or a standby LC. But in the short-term field the most common documentation is without any doubt the LC payable at 60-90 days sight orfrom shipment date.

If this is the case, the procedure the exporting house has to apply is quite simple and consists of four steps:

1st step : Sign the supply agreement and soon after the forfaiting contract.

Once the supply agreement has been entered between the buyer and the seller, it is advisable forthe latter to get a commitment from a reliable forfaiting house to discount on a non-recourse basis his



claims under the LC. This commitment will list the specific terms under which the forfaiter undertakes topurchase the LC claims, i.e.:

discount rate, possibly on a straight basis thus waiving the fluctuation risk on Libor rate onaccount of the seller;

grace days;

commitment fee;

documentation required;

expiry date, i.e., the latest date within which the required documentation has to be presented at thecounters of the forfaiter.

2nd step:

Ship the goods and negotiate relevant documents under the LC. The LC is a very delicateinstrument and to make it work, the seller must take care that all LC terms have been satisfied and that alldocuments complied with; evidence of that is needed for the forfaiter to materialise the transaction.

3rd step :

Send the forfaiter all documents required under the forfaiting contract, i.e.:

conformed copy of the LC and of any subsequent amendment thereto;

letter of assignment of the LC claims under Article 49 of UCP- ICC Publication no. 500;

conformed copy of „notification of assignment‟ addressed to all parties involved, i.e. advisingbank, issuing bank, applicant, etc;

conformed copy of some specific documents, such as:

– commercial invoice – transport document – negotiating bank authenticated message confirming that all documents under the LC have been

received and found in conformity with the LC terms and fixing the due dates for the LC payment.

4th step :

This step concerns the control by the forfaiting house of the documents received and thisnormally requires three to 10 days depending on the complexity of the deal and on the timing to get thenecessary answers from the LC issuing bank. Once the check is completed, the forfaiter arranges for animmediate remittance of the LC net proceeds to the seller on his bank account.



Actions:

1. The buyer and the seller sign the supply agreement.

2.

The seller gets a forfaiter‟s commitment to purchase the LC claims and both sign the relevantcontract.

3. The buyer gives instructions to his banker to open a deferred payment LC and notify it to theseller through a correspondent local bank.

4. The seller ships the goods as per the supply agreement and then presents all the documentsrequired under the LC at the advising bank.

5. The advising bank sends the documents to the issuing bank who negotiates the credit and releasesa swift message to the presenting bank stating that all documents are in order and comply with theLC terms.

6. The seller assigns the forfaiter all his rights deriving from the LC claims according to Article 49 – UCP 500, and asks him to provide the seller‟s banker with the agreed LC net proceeds as per theforfaiting contract.

Benefits:-



Final financing facilities ¨C forfeiting is a kind of trade financing facility without recourse, onceyou obtain financing payments, you will not be responsible for the solvency of the debtors any more;Meanwhile the banking credits will not be occupied;

Improve cash flow ¨C change long term receivables into current cash inflow to improve yourfinancial situation and liquidity, to avoid occupation of capital and further improve your financingcapability;

Handle tax return in advance ¨C after getting forfeiting service, you can handle foreign exchangeand export tax return procedures immediately;

Avoid all kinds of risks - after getting forfeiting service, you will not be exposed to the risksrelated to interest rates, exchange rates, credits and nations etc;

Increase trade opportunities ¨C you can enable transaction with buyer through thecondition of delayed payment, to avoid the situation that transaction cannot be carried outbecause the buyer is short of capital;

The benefits to the seller from forfaiting include eliminating political, transfer, and commercialrisks and improving cash flows. The benefit to the forfeiter is the extra margin on the loan to the seller.