What is Factoring? Why is the Factoring Regulation (Amendment) Bill so important?

The Factoring Regulation (Amendment) Bill, 2020 was introduced in Lok Sabha on September 14, 2020.  It aims to widen the scope of NBFCs that can engage in factoring business by amending the Factoring Regulation Act, 2011.

Let’s begin by understanding what factoring is –

Businesses utilize invoice factoring as a way to fund cash flow by selling their invoices to a third party (a factor, or factoring company) at a discount. The factoring of invoices can be done by NBFCs, or by banks. It is also known as Debt factoring; Invoice finance; Asset based lending.

How it works

• Business owners enter into an agreement with the factoring company whereby the company manages the sales ledger and credit control on a continual basis for a fixed term (typically 24 months).
• As a result, the factoring company advances some funds in advance when the business client sends an invoice to a customer, typically 70-85% of the amount.
• Factoring companies collect the debt from end customers, and then make the remaining balance available to business clients, minus their fees.

Benefits of factoring

In exchange for a fee, factoring companies unlock funds out of unpaid invoices so that your business receives cash sooner. This makes cash flow management easier for the businesses that use factoring. Most factoring companies also focus on credit control, removing the need for the business to chase customers for invoice payments. This saves a lot of administration time for the business.

Why is Factoring Regulation (Amendment) Bill 2020 important for India?

The previous legislation on factoring business was enacted in 2011 which gave the Reserve Bank of India authority to allow non-bank finance companies to remain in factoring business if that was their principal business. In other words, over half of assets were to be deployed and income earned from factoring. This bill removes this threshold and opens this business opportunity to more NBFCs at a time when small businesses are facing financial stress.

More than six crore MSMEs exist across the country, which are a major source of employment in rural and urban areas. In addition, they contribute about 45% of India’s manufacturing output, more than 40% of exports, and around 30% of its GDP.

At this time, with the new Factoring Regulation Bill, MSMEs will have more NBFCs to arrange working capital through bill discounting, thus shortening the cycle of taking up new work consignments due to piling up of stuck invoices. Currently there are only 7 Factoring companies in India, with this bill the government aims to increase the number of companies offering factoring to over 9,500.

The current market size of factoring business in India is approx. $6 Billion and the total contribution of factoring business to India’s GDP is only 0.2%. With the recent development of the Factoring Regulation Amendment Bill 2020 the government aims to ease regulations and permissions required for NBFCs to venture into Factoring business.

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