Section II :Chapter:6
1.
Define HP agreement and terms of agreement
Hire purchase is a mode of financing the price of the goods to be sold on a future date. In a hire purchase transaction, the goods are let on hire, the purchase price is to be paid in installments and hirer is allowed an option to purchase the goods by paying all the installments. Hire purchase is a method of selling goods. In a hire purchase transaction the goods are let out on hire by a finance company (creditor) to the hire purchase customer (hirer). The buyer is required to pay an agreed amount in periodical installments during a given period. The ownership of the property remains with creditor and passes on to hirer on the payment of the last installment.A hire purchase agreement is defined in the Hire Purchase Act, 1972 as peculiar kind of transaction in which the goods are let on hire with an option to the hirer to purchase them, with the following stipulations:
a. Payments to be made in installments over a specified period.
b. The possession is delivered to the hirer at the time of entering into the contract.
c. The property in goods passes to the hirer on payment of the last installment.
d. Each installment is treated as hire charges so that if default is made in payment of any installment, the seller becomes entitled to take away the goods, and
e. The hirer/ purchase is free to return the goods without being required to pay any further installments falling due after the return.
Hire Purchase Agreemnt A hire purchase agreement is in many ways similar to a lease agreement, in so far as the terms and conditions are concerned. The important clauses in a hire purchase agreement are:
1. Nature of Agreement: Stating the nature, term and commencement of the agreement.
2. Delivery of Equipment: The place and time of delivery and the hirer’s liability to bear delivery charges.
3. Location: The place where the equipment shall be kept during the period of hire.
4. Inspection: That the hirer has examined the equipment and is satisfied with it.
5. Repairs: The hirer to obtain at his cost, insurance on the equipment and to hand over the insurance policies to the owner.
6. Alteration: The hirer not to make any alterations, additions and so on to the equipment, without prior consent of the owner.
7. Termination: The events or acts of hirer that would constitute a default eligible to terminate the agreement.
8. Risk: of loss and damages to be borne by the hirer.
9. Registration and fees: The hirer to comply with the relevant laws, obtain registration and bear all requisite fees.
10. Indemnity clause: The clause as per Contract Act, to indemnify the lender.
11. Stamp duty: Clause specifying the stamp duty liability to be borne by the hirer.
12. Schedule: of equipments forming subject matter of agreement.
13. Schedule of hire charges.:The agreement is usually accompanied by a promissory note signed by the hirer for the full amount payable under the agreement including the interest and finance charges. So far we discussed the legal aspect, let’s now discuss the taxation aspect of the hire purchase agreement.
Taxation Aspects
The taxation aspects of hire purchase transaction can be divided into three parts (a) Income Tax, (b) Sales Tax and (c) Interest Tax.
4. Types of leasing – Operating v/s Financial lease.
The Indian company investors must be acknowledged that lease is that agreement under which the company or Indian firm acquire the exact right and make use of certain capital asset on the consideration of payment of rental charges. The Indian corporate company must equally known that it cannot equally know that it cannot acquire any kind of ownership to such an asset apart from making use of it. The user comparatively pays all the expected operating costs and also the maintenance expenses. The main corporate companies must equally take into the consideration that developed countries like America, United Kingdom the companies of such a countries are commonly depending on the leasing factor. In India since the era of liberalization, many of the Indian companies have equally been involved in the leasing transactions. On the other side, many financial institutions and even the commercial banks in the Indian financial sector have comparatively been accepted over the same transactions.
Lease is a contractual arrangement where the owner, say lessor of equipment transfers the right to use the equipment to the user lessee for an agreed period of time in return for rental. Lease can be classified as under:-
1) Finance Lease and operating lease
2) Sale and lease back and direct lease
3) Single investor lease and leveraged lease
4) Domestic Lease and international lease
16. What is factoring? Explain Factoring Modus operandi (process of factoring with diagram)
MECHANICS OF FACTORING:- An agreement between the firm selling goods or services and the factor is made to specify the legal obligations and procedural arrangements. When the firm receives an order from a buyer, a credit approval slip is written and immediately sent to the factoring concern for a credit check. The factor can give his decision quickly because he maintains elaborate credit files on selected companies. If the sale is approved by the factor, the goods are dispatched and invoice is clearly marked with an inscription notifying the buyer of the goods that the account has been sold and the payment be made direct to the factor. Notification is a distinctive feature of factoring and not found in any other form of financing receivable. It is the keystone upon which the services of factor are based.
17. Types of factoring, Costs & Benefits of factoring
Factoring services started in the United States of America in the 1920s and were introduced to the other parts of the world in the 1960s. Today there are more than 900 companies offering factoring services in more than 50 countries. Factoring services have become quiet popular all over the world. Factoring is a financial service covering the financing and collection of accounts receivables in domestic as well as in international trade. Basically factoring is an arrangement in which receivables on account of sale of goods or services are sold to the factor at a certain discount. As the factor gets title to the receivables on account
of the factoring contract, he becomes responsible for all credit control, sales ledger administration and debt collection from the customers.
Functions of the Factor
Broadly speaking the main functions of the Factor are as under :
1) To provide finance against book debts, say upto 90 per cent of the invoice value immediately. Thus the client gets funds immediately for his working capital.
2) To collect cash against receivables on due date from the customers of the clients and furnish reports to the client.
3) To undertake sales ledger administration (i.e. accounting work) for the client in respect of client’s transactions with its customers.
4) Under the non-recourse factoring arrangement, if the customer become financially insolvent and cannot pay up, the Factor provides protection to the client against bad debts on all approved invoices. Thus the Factor provides debt insurance facility to the client against possible losses arising from insolvency or bankruptcy of the customer.
5) Factor also provides other information such as sales analysis and overdue invoice analysis which enable the client to run the business more effectively. Besides, the Factor also provides relevant expertise in the areas of marketing, finance, etc., to the client
There are three parties involved generally in a factoring contract, viz.,
1) Buyer of goods (i.e. customer) who has purchased goods or services on credit and as such has to pay for the same once the credit period gets over.
2) Seller of goods (i.e. client) who has supplied goods or provided services to the customers on credit terms.
3) ‘Factor’ who purchase the invoices (receivable) from seller of goods and collect the money from the
ADVANCE FACTORING:- This kind of factoring institution is prepared to pay for debts in advance of receiving the payment due from the customers. This is only a prepayment and not an advance. A drawing limit is made available to the client as soon as the invoice is accounted for. INVOICE DISCOUNTING INSTITUTION:- Under this arrangement the factor buys all or selected invoices of its client at a discount. The factoring institution does not maintain sales ledger for its client nor undertakes debt collection function. It only provides finance to its client. DISCLOSED FACTORING:- In disclosed factoring client's customers are notified of the factoring agreement. Disclosed type can either be recourse or non recourse.
UNDISCLOSED FACTORING:- In undisclosed factoring, client's customers are not notified of the factoring arrangement. Sales ledger administration and collection of debts are undertaken by the client himself. Client has to pay the amount to the factor irrespective of whether customer has paid or not. But in disclosed type factor may or may not be responsible for the collection of debts depending on whether it is recourse or non recourse. BUYER-BASED FACTORING INSTITUTION:- Buyer-based factoring institution is concerned with factoring all the buyer’s payables. Thus, the factor would maintain a list of ‘approved buyers’ and any claims on such buyer (by any seller) would be factored without recourse to the seller. SELLER-BASED FACTORING:- This type of factoring institution takes over the credit function of the seller entirely. After invoicing its customer the seller Submits a copy of the invoice, the delivery Challan, the buy sell contract and related papers like quality stipulations and test certificate to the factor who takes over the remaining operations like reminding the buyer for payment, maintaining its account and collecting the amount. The seller closes his transaction after assigning the debt to the factor, by treating the transaction as a cash sale. In such a case, the factor is also able to supply additional information to the management, viz; approved, unapproved and disputed claims utstanding, sales analysis by area, by salesman, by products, etc; excise and sales tax payments and the like.
The various types of factoring arrangements can be classified into the following categories.
1) Full Servicing Factoring: This is also known as without recourse factoring service. It is the most comprehensive type of factoring arrangement offering all types of services, namely: (a) Finance, (b) Sales ledger administration, (c) Collection, (d) Debt protection, and (e) Advisory services. The most important characteristic of
this type of factoring service is that it gives protection against bad debts to the client. In other words, in case the customer fails to pay, the factor will absorb the losses arising from insolvency or bankruptcy of the client’s customers.
2) Recourse Factoring: In such a type of factoring arrangement, the factor provides all types of facilities except debt protection. That means, in other words, the client is responsible for any bad debts arising from insolvency of the client’s customers.
3) Maturity Factoring: Under this type of factoring arrangement, except for providing finance, all other facilities are provided to the client. As far as finance is concerned, the client is paid at the end of a pre-determined date or maturity date whether or not the customers have settled their dues in respect of credit sales.
4) Invoice Discounting: In such type of arrangement, only finance is provided, and, hence, no other services are offered in respect of receivables.
5) Agency Discounting: Under this arrangement, the facilities of finance and protection against bad debt are provided by the factor. As against this, the sales ledger administration and collection of book debts are carried out by the client himself.customers of his clients.
Benefits of Factoring to Clients
1)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.2) 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. 3) 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.4) 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 5) factoring may not be useful
Cost of Factoring
These are two types of costs in factoring services
1. Service Fee or Charges
2. 2. Discount Charges
Service Fee: Service fee is levied for the work involved in administering the sales ledger as well as protection against bad debts. It is calculated as a percentage of gross value of the invoices factored and is assessed on the following criteria:
a) Gross annual sales volume;
b) Number of customers;
c) Number of invoices and credit notes; and
d) Degree of risk represented by the customer.
The service fee for domestic factoring ranges from 0.30 per cent to 0.75 per cent and it would be higher when non-recourse arrangements are made.
2) Discount Charge (interest charge): The discount charge is levied on the advance provided by the factor and is computed on the basis of prime lending rate of banks plus premiums for credit risk basis. It is calculated on a day-to-day basis on the advances outstanding and ranges from 1 to 3 per cent above the reference bank’s prime lending rate.
Distinguish between factoring and Bill Discounting, Distinguish between factoring and forfeiting.
Factoring vs. forefeiting
1) Factoring services is mainly meant for financing and collecting of receivables arising from short term credit transactions say upto 180 days. As against this, Forfaiting is meant for financing credit transactions of having deferred credit period of more than 1 year.
2) Factoring arrangement can be with recourse or without recourse depending on the terms of factoring contract between a client and a factor. As against this, Forfaiting transaction is always without recourse where forfeiter absorbs credit risk also.
3) Factoring services can be considered either for domestic transaction or for export transaction. As against this Forfaiting transaction is always considered for export transactions only.
4) Factoring is done on the strength of sales invoices only. Whereas Forfaiting involves use of availised negotiable instruments like bill of exchange or promissory note.
5) In a factoring arrangement, a margin of 5 to 20 per cent is kept. In other words, finance is provided immediate on the purchase of invoice to the extent 80 to 95 per cent of invoice value. As against this; a forfaiter discounts the entire sale value of the export transaction without keeping any margin.
6) Factoring services include sales ledger, administration, collection of receivables and other advisory services. On the other hand, Forfaiting is a pure financial arrangement.
7) Factoring is done on whole turnover basis, whereas, Forfaiting can be done on transaction basis.
20. Factoring in India vs international factoring and what are the benefits of international factoring?
Though factoring services have been introduced since 1991 in India still it is quite new in the sense that factoring product is not widely known in many parts of the country. Recognising the utility of factoring services for small and medium size industrial and commercial enterprises in India, for the first time the Vaghul Committee which submitted its report on the Money Market, recommended the development of a system of factoring of open account sales particularly for the small scale industrial units. This committee further observed that both banks and non-bank financial institutions in the private sector should be encouraged to set up institutions for providing factoring services. Later, the Kalyanasundaram Committee, which was appointed by the Reserve Bank of India (RBI) in 1988 specifically for exploring the possibilities of launching factoring services in India, found an abundant scope for such services and hence strongly advocated for the introduction of factoring services in India. This committee also observed that banks were ideally suited for providing factoring services to the industries in the economy. However, the said Committee expressed the view that to begin with only four or five banks either individually or jointly should be allowed on zonal basis to undertake factoring services. The recommendations of Kalyanasundaram Committee were accepted by the RBI. Subsequently a suitable amendment was made in the Banking Regulation Act 1949, so as to allow banks to set up subsidiary company for undertaking factoring services.
To begin with, the RBI permitted both the State Bank of India and Canara Bank to start factoring services through their own subsidiaries. Accordingly, two factoring companies in India, i.e. SBI Factors and Commercial Services Ltd. and Canbank Factors Ltd; sponsored by the State Bank of India and Canara Bank respectively, commenced operations in 1991. In the beginning they were allowed to operate in Western and Southern Zone of India respectively. However, later on, the RBI lifted these area restrictions on their operations and accordingly, both these companies were given permission to expand and operate their business in other parts of the country. In view of this, they can operate on all-India basis. In 1993 the RBI allowed all the scheduled commercial banks to introduce factoring services either departmentally or through a subsidiary set-up. Besides SBI Factors and Commercial Services and Canbank Factors Ltd., there are a few non-banking finance companies such as Formost Factors Ltd., Global Trade Finance Pvt. Ltd. (a subsidiary of EXIM Bank) and Integrated Financial Services Ltd., which are also in the business of domestic factoring in India. Of these, Global Trade Finance Pvt. Ltd. and Formost Factors Ltd. have undertaken the business of export factoring also. Besides these non-banking finance companies, Small Industries Development Bank of India (SIDBI), Hongkong and Shanghai Banking Corporation have been offering factoring services to their clients. Almost all of them have been providing factoring services to the SSI and non-SSI units.
21. Explain Features and characteristics of Forfeiting. Benefits & Drawbacks of Forfeiting
Features of a Forfaiting Arrangement
1) It is a specific form of export trade finance.
2) Export receivables are discounted at a specific but fixed discount rate.
3) Debt instruments most commonly used in Forfaiting arrangement are a bill of exchange and a promissory note.
4) Payment in respect of export receivables which is further evidenced by bill of exchange or promissory notes, must be guaranteed by the importers’ bank. The most usual form of guarantee attached to a Forfaiting agreement is an aval.
5) It is always without recourse to the seller (viz. Exporter).
6) Full value of export receivables i.e. 100 per cent of the contract value is taken into account.
7) Normally the export receivables carrying medium to long term maturities are considered.
The benefits accruing to the exporter are numerous. Few of these benefits are stated below:
1) Exporter can convert export transaction under deferred payment arrangement into a cash transaction. Thus he can improve his own liquidity position.
2) Since the forfaiter takes all risks, naturally exporter is relieved of the risks arising out of the default by the buyer (importer) as also the political and exchange risk.
3) Since the Forfaiting is a fixed rate contract, the exporter is hedged against interest rate risk and exchange rate risk.
4) Exporter gets finance upto 100 per cent of the contract value (which is to be reduced to the extent of Forfaiting cost).
5) Exporter is freed from credit administration and collection problems.
23. Benefits & Demerits of credit cards
Credit cards are a simple and convenient means of access to short term credit for consumers. They enable the consumer to:
(a) Dispense with using cash for every transaction.
(b) Make Monthly payments.
(c) No interest charges if paid on due date every month.
(d) Insurance benefits are available.
(e) Special discounts can be availed which are not applicable on cash transactions.
(f) For high value purchases the consumer can use the roll over facility and pay for his purchases in instalments.
The disadvantages of credit cards are:
(a) The consumer commits his future income.
(b) If not used wisely the consumer lands into a debt trap.
(c) The rate of interest on credit cards for long term finance (roll over) is around 40% per annum.
1) Risk involved in derivative markets
· Price risk
· Credit risk
· Default risk/ Counter party risk
· Liquidity risk
· Foreign exchange rate fluctuation risk
· Portfolio risk
· Market risk
· Legal risk
· Settlement risk
· Operation risk
· Systematic risk
Besides the “price risk” of potential losses on derivatives from changes in interest rates, foreign exchange rates, or commodity prices, there is “default risk” (sometimes referred to as “counterparty risk” ), “liquidity (or funding) risk,” “legal risk,” “settlement risk” (or, a variation thereof, “Herstatt risk”), and “operations risk.” Last, but not least, is “systemic risk’’—the notion of problems throughout the financial system that seems to be at the heart of many regulatory concerns
2) Demerits of international factoring
Factoring is a financial service covering the financing and collection of accounts receivables in domestic as well as in international trade. The major demerits are :-
· Cost
· Possible harm to customer relation
· Company image distortion
· Factoring may impose constraints on the way business is done
Disadvantages To Exporter
· Cost: Export factoring can potentially cost more since two factor firms are involved.
· The exporter has the responsibility to ensure that the debt instruments are validly prepared.
· The exporter must insure that there are no disputes over product quality or performance.
· Potential loss of control over customer relationship management.
· Exporter may need to meet minimum factor volume levels
3) Disadvantages of bill discounting
1) Reluctance of industry as well as trade and Government undertakings as well as departments to move towards bill financing since it does require observance of strict financial discipline. In other words, industries and Government departments are not prepared to subject themselves to the strict commitment to honour financial obligations on the agreed date.
2) The procedural delay involved in the creditor getting a prompt legal remedy in case of dishonoured bills.
3) With the era of globalisation and reforms in the economy, the domestic market has become highly competitive and has turned into a buyer’s market. As a result, sellers of goods are not able to bring around the buyers to accept bill of exchange for sale of goods on credit. From the buyer’s point of view, they
would like to retain the character of the transaction as a pure credit transaction with simple debtor-creditor relationship rather than elevate it to a negotiable instrument.
4) Operational and procedural constraints in the discounting and rediscounting of bills.
· Lack of uniformity in the documents to be submitted for availing bill discounting facility.
· Wide geographical spread of the buyers
· Delay on the part of drawers bank in sending the bills for presentation/ acceptance
· Delay on the part of drawee in accepting the bills within a reasonable time frame.
· Delay in remittance of proceeds by the bank at the drawee’s end.
· Delay in the approval of new customers (drawees) in the absence of reliable credit information especially in respect of small and medium size enterprises as well as unlisted and unincorporated entities.
5) Cost of availing credit through bill discounting is perceived to be high compared to cost of cash credit facility. In addition to the discounting charges, collection and handling charges are also levied. In view of this, effective cost of bill discounting turns out to be rather high especially in case of bills of smaller amount.
6) Before approving a bill for discounting the following should be ensured by the banker :
i. The signature as well as credit limit of the bank’s borrowers have been verified. (Need to ensure that limit for bill discounting has been sanctioned by the credit manager).
ii. The nature of the transaction is mentioned on the bill and all invoice details are provided. There is a need to verify and ensure that bill is drawn against a genuine trade transaction. (i.e. bill covers only sale of goods transactions).
iii. The original tenor of the bill does not exceed 120 days if Bill Discounting Facility is to be availed of.
iv. The payment instructions and maturity date are clearly mentioned on the bill. The bill is drawn in favour of or endorsed to the discounting bank.
v. All material alterations have been authenticated.
vi. Notice of dishonour and presentment have been waived.
7) Features of financial derivative
Financial derivatives markets trade contracts that have a financial asset or variable as the underlying. The more popular financial derivatives are those which have equity, interest rates and exchange rates as the underlying. The following features have been driving the growth of financial derivatives:
1. Increased volatility in asset prices in financial markets,
2. Increased integration of national financial markets with the international markets,
3. Marked improvement in communication facilities and sharp decline in their costs,
4. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and
5. Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets, leading to higher returns, reduced risk as well as trans-actions costs as compared to individual financial assets.
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