Description
In addition to debt and equity financing, leasing has emerged as a third important source of intermediate long-term financing, Prior to 1950, leasing was primarily concerned with real estate i.e., Land & building.
LEASING
INTRODUCTION & ORIGINATION
? The main objective of any business is to maximize the
owner?s economic welfare by EXPANDING,
DIVERSIFYING ACTIVITIES.
? In addition to debt and equity financing, leasing has
emerged as a third important source of intermediate long-
term financing.
? Prior to 1950, leasing was primarily concerned with real
estate i.e., Land & building.
CONTINUED….
?In 1973 the concept was introduced by First
Leasing Company of India Ltd.
?Then some public & private sector players
were involving in lease financing like ICICI &
GIC.
MEANING
? It is an arrangement that provides a firm with the use &
control over assets without buying and owning the same.
? It is a form of renting assets.
? It is a contract between the owner of the asset (lessor) & the
user of the asset called lessee, whereby the lessor gives the
right to use the asset to the lessee over an agreed period of
time for a consideration called the lease rental.
DEFINITION
?“Lease is a form of contract transferring the use
or occupancy of land, space, structure or
equipment, in consideration of a payment,
usually in the form of a rent.”
?Lease rental may be payable at the beginning or
end of a month, quarter, half-year or year.
?There is option to buy or renew the lease
ESSENTIAL ELEMENTS OF LEASING
?No. of parties to the contract
?Asset/Property/Equipment
?Consideration(lease rentals)
?Lease period
?Termination of contract
WHY LEASING ?
? A flexible investment instrument;
? A way of broadening the financing options available
to local companies;
? An efficient way to finance investment in capital
assets by new companies;
? Attractive for financing small and medium
enterprises.
TYPES OF LEASE AGREEMENTS
?Operating/Service Lease.
?Financial Lease.
?Leverage Lease.
?Sale & Leaseback.
?Cross Border Lease.
OPERATING LEASE
? It is a short-term lease on a period to period basis. The
lease period in such a contract is less than the useful life of
the asset.
? The lease is usually cancellable at a short notice by the
lessee.
? The lessee usually has the option of renewing the lease
after the expiry of lease period.
? The lessor is responsible for maintenance, insurance &
taxes of the asset.
? Higher risk to lessor & higher rental to lessee.
? Example: Computers, Vehicles.
FINANCIAL LEASE
? Long-term & non-cancellable in nature.
? Alternative to debt financing and assets are concerned like
land, building, machinery.
? Lessor recovers his investments along with an acceptable
rate of return.
? Lessee is responsible for the maintenance, insurance, and
service of the asset.
? Renewal or buying option attached.
? Examples: Machine Tools, Textile Machinery, Containers,
Locomotives etc.
LEVERAGED LEASE
? It is an arrangement under which the lessor borrows funds
for purchasing the asset, from a third party called lender
(Bank/Finance co.).
? The loan is secured by the mortgage of the asset.
? Lease rentals to be received from the lessee and excess
amounts remitted to the lessor.
? Example: Coal Mining, Pipe lines, Ships, Electricity
Generating Plants etc.
SALE & LEASEBACK
? The firm Which has an asset sells it to the leasing
company and gets it back on lease & makes periodical
rental payments.
? It is suitable for the firms facing shortage of working
capital funds.
? Chances of repurchase in some cases.
? Example: Retail stores/Shopping Centres, Office
Building.
CROSS BORDER LEASE
?It is an international leasing and both parties
are not belonging to the same country.
?Example: USA makes available an Airbus to
Air india.
TAX IMPLICATION
? Lessee can deduct lease payments for income tax purposes.
CONDITIONS
? Must be used for business purposes and not to avoid
taxes.
? Should not include an option to acquire the asset at the
end of the lease at a below market price.
? Lease payments should not start high and then drop
dramatically.
? Renewal options must be reasonable and consider fair
market value at the time of the renewal
ADVANTAGES OF LEASING
Advantages to the Lessee
? Avoidance of Initial Cash Outlay.
? Minimum Delay.
? Easy Source of Finance.
? Shifting the risk of Obsolescence .
? Enhance Liquidity.
? Tax Advantage.
? Flexibility & Convenience.
? No Floatation Cost.
ADVANTAGES OF LEASING
Advantages to the Lessor
? Higher Profits
? Tax Benefits (Depreciation & Investment Allowance)
? Quick Returns
? Increased Sales of leased assets
HIREPURCHASE-MEANING
? It means a transaction where goods are purchased
and sold on the following terms that:
? Payment will be made in installments.
? Possession of goods transferred immediately.
? Ownership remains with the seller.
? Seller can repossess in case of default.
? Each installments are treated as hire charges.
DEFINITION
? The hire purchase act, 1972 defines a HP agreements as
“an agreements under which goods are let on hire and
under which the hirer has an option to purchase them in
accordance with the terms of the agreement & includes
an agreement under which:
? Transfer of possessions & periodical payments.
? Ownership transferred on payment of last installment
? Hire purchaser has a right to terminate the agreement.
DIFFERENCE BETWEEN HP &
INSTALLMENT PURCHASE
? Actual Sale
? Legal Ownership
? Right to sale
? Legal protection
? Rights of seller
? Bad Debt
LEASE OR BUY DECISION
? The cost of leasing the asset should be compared with
cost of financing the asset through normal source of
financing i.e., debt or equity.
? Calculate the present value of net cash flow of the buying
option called NPV(B).
? Calculate present value of net cash outflow of the leasing
option called NPV(L),
? If NPV(B)< NPV(L)-BUY
? If NPV(L)< NPV(B)-LEASE
* Fresh Water Drilling Company needs an additional drilling
Machine at the cost of Rs. 15 lakhs for sinking bore wells. At
present, it can not spare its own funds to buy the equipment. The
company has to either borrow funds from the bank or taken on lease
the equipment for five years.
* The bank charges 15 per cent interest rate & the instalments can
be paid at the year end for the stipulated lease of five years.
* The salvage value is Rs. 1.5 lakhs.
* In the case of leasing, a rent of Rs. 4.95 lakhs is charged at the
end of the year.
* The rate of depreciation allowed on the equipment is 15 % on
diminishing balance method.
?The company has to pay income tax @ 50 per cent and has a
discounting rate of 14 per cent.
Evaluate the two options and give your suggestions excluding
capital loss on sale of machine.
BORROW AND PURCHASE OPTION (RS.
IN ,000)
Year
(1)
Principal
Repayment
(2)
Interest at
15 %
(3)
Depreciatio
n
(4)
Tax Shield
(3+4)x50 %
(5)
Net Cash
Outflow
(2+3)-(5)
(6)
PV
14 %
(8)
Discounted
Cash
Outflow
(9)
1
2
3
4
5
Les
s
300
300
300
300
300
PV of
225
180
135
90
45
Salvage
Value of
asset
225
191.25
162.56
138.18
117.45
225
185.63
148.78
114.09
81.23
300
294.37
286.22
275.90
263.78
(150)X
(0.519)
0.877
0.769
0.675
0.592
0.519
263.10
226.37
193.20
163.34
136.90
982.91
-77.85
905.06
SCHEDULE OF DEPRECIATION
RS. IN,000
Year Depreciation
Balance at the
End of the year
1 1500x015= 225
1275
2 1275x0.15=191.25
1083.75
3 1083.75x0.15=162.56
921.19
4 921.19x0.15=138.18
783.01
5 783.01x0.15=117.45
665.56
LEASE OPTION (RS.
IN ,000)
Year Lease
Rentals
Tax Shield
50 % of (2)
Net Cash
Outflow (2)-(3)
PV Factor
14 %
Discounte
d Cash
Outflow
(1) (2) (3) (4) (5) (6)
1-5 495 247.5 247.50 3.433 849.67
Lease option is more profitable for the company because the
cash outflow under leasing (849.67) is lesser than borrowing
& purchasing (905.06) option
CASE STUDY 2
?XYZ Ltd. is in the business of manufacturing a product A. The firm
is planning to diversify and add a new product line in the firm either
by purchasing the required machinery or get it on lease.
? The cost of the machinery is Rs.15 lakh and its expected useful
life is 5 years with scrape value of Rs.1 lakh. The machinery can be
financed by loan @ 20% interest p.a. repayable in 5 annual
installments inclusive of interest being due at the end of each year.
? Alternatively the machine can be taken on year end lease rental of
Rs.4.5 lakh for five years. Rate of depreciation is 25% p.a. & method
to be followed is WDV. Tax rate is 35%. Maintenance expenses is
Rs.30000 per year are to be borne by lessee. Advice the company
whether to buy or lease.
PRESENT VALUE OF CASH OUTFLOW UNDER LEASING
RS
Year end Lease Rent after taxes
Lease Rental*(1-t)
450000*(1- 0.35)
PVIFA@13%
Interest*(1-t)
20%*(1-0.35)
PV OF Cash
Outflow
1 to 5 292500 3.517 1028723
PV OF CASH OUTFLOW UNDER BUYING
Year
end
Loan
Installmen
t
Tax
advantage
on Interest
Tax
advantage
on
Depreciation
Net Cash
Out flow
PVIF
@13%
PV of
Cash
Outflow
1
501505 105000 131250 265255 0.885 234751
2
501505 90895 98437 312173 0.783 244431
3
501505 73968 73828 353709 0.693 245120
4
501505 53656 55371 392478 0.613 140589
5
501505 29114 41528 430863 0.543 233959
Total
LESS: PV
OF SCRAP
100000*0.543
54300
1198850
LESS: PV of
Tax saving
on capital
loss
(355958-
100000)*0.35*0
.543
48645
Cash
outflo
w
102945
1095905
SCHEDULE OF DEBT PAYMENT
Year end
Loan
installment
Loan at begin
of the year
Interest
Payments
Principal
Payments
Loan
Outstanding
at the end of
the year
1 501505 1500000 300000 201505 1298495
2 501505 1298495 259699 241806 1056689
3 501505 1056689 211338 290167 766522
4 501505 766522 153304 348201 418321
5 501505 418321 83184* 418321 0
EAI = Rs.1500000/2.991 (PVIFA for five years at 20%) =Rs.501505
SCHEDULE OF DEPRECIATION
Year Depreciation Balance
1 1500000*0.25=375000 1125000
2 1125000*0.25=281250 843750
3 843750*0.25=210937 632813
4 632813*0.25=158203 474610
5 474610*0.25=118652 355958
Suggestion: The Company should lease the asset because the cash outflow in
lease option is less than buying option.
FACTORING-ORIGIN
Factoring services started in US in early 1920s and were
introduced to other parts in 1960s
Kalyana Sundaram Committee recommended introduction
of factoring in 1989.
Banking Regulation Act, 1949, was amended in 1991 for
Banks setting up factoring services.
SBI/ Canara Bank have set up their Factoring
Subsidiaries:-
?SBI Factors Ltd., (April, 1991)
?CanBank Factors Ltd., (August, 1991).
FACTORING
Factoring is the Sale of Book Debts by a firm (Client) to a
financial institution (Factor) on the understanding that
the Factor will pay for the Book Debts as and when they
are collected or on a guaranteed payment date.
Normally, the Factor makes a part payment (usually up to
80%) immediately after the debts are purchased thereby
providing immediate liquidity to the Client.
FACTORING SERVICES - CONCEPT
Client
Customer
Factor
Order placed
Deliver of goods
Client submits
invoice
Factor-Prepayment
Monthly statements
Customer pays
PROCESS INVOLVED IN FACTORING
? Client concludes a credit sale with a customer.
? Client sells the customer’s account to the Factor and notifies the
customer.
? Factor makes part payment (advance) against account purchased,
after adjusting for commission and interest on the advance.
? Factor maintains the customer’s account and follows up for
payment.
? Customer remits the amount due to the Factor.
? Factor makes the final payment to the Client when the account is
collected or on the guaranteed payment date.
SERVICES/FUNCTIONS OFFERED BY A FACTOR
? Follow-up and collection of Receivables from Clients.
? Sales ledger management.
? Purchase of Receivables with or without recourse.
? Help in getting information and credit line on
customers (credit protection)
? Sorting out disputes, if any, due to his relationship with
Buyer & Seller.
TYPES OF FACTORING
? Disclosed & Undisclosed Factoring
? Recourse Factoring
? Non-recourse Factoring
? Advance & Maturity Factoring
? Cross-border Factoring
DISCLOSED & UNDISCLOSED FACTORING
? In case of disclosed factor the name of the
proposed factor is mentioned on the face of the
invoice made out by the seller of goods.
? Under undisclosed factor the name of the proposed
factor finds no mention on the invoice made by the
seller. Although, the control remains with the factor.
RECOURSE FACTORING
?Factor purchases Receivables on the condition that loss
arising on account of non-recovery will be borne by the
Client.
?Credit Risk is with the Client.
?Factor does not participate in the credit sanction process.
?In India, factoring is done with recourse.
NON-RECOURSE FACTORING
?Factor purchases Receivables on the condition that loss
arising on account of non-recovery will be borne by the
factor.
?Credit risk is with the Factor.
?Higher commission is charged.
?Factor participates in credit sanction process and
approves credit limit given by the Client to the Customer.
?In USA/UK, factoring is commonly done without
recourse.
ADVANCE FACTORING
?The factor makes an advance payment in
the range between 70-80 per cent.
?Factor collects interest on the advance
payment from the client.
MATURITY FACTORING
?Factor does not make any advance payment to the
Client.
?Pays on guaranteed payment date or on collection of
Receivables.
?Guaranteed payment date is usually fixed taking into
account previous collection experience of the Client.
?Nominal Commission is charged.
?No risk to Factor.
CROSS - BORDER FACTORING
? It is similar to domestic factoring except that there are four parties, viz.,
a) Exporter,
b) Export Factor,
c) Import Factor, and
d) Importer.
? It is also called two-factor system of factoring.
? Exporter (Client) enters into factoring arrangement with Export Factor in
his country and assigns to him export receivables.
? Export Factor enters into arrangement with Import Factor and has
arrangement for credit evaluation & collection of payment for an agreed
fee.
? Notation is made on the invoice that importer has to make payment to
the Import Factor.
? Import Factor collects payment and remits to Export Factor who passes
on the proceeds to the Exporter after adjusting his advance, if any.
? Where foreign currency is involved, Factor covers exchange risk also.
Exporter Importer
Country A Country B
Export Factor
Import Factor
Goods and invoices – Stage I
Copy Invoice Stage II
Prepayments Stage III
Copy Invoices Stage IV
Statements Stage V
Payments
Stage VI
Payments Stage VII
Payment of Commission Stage VIII
STATUTES APPLICABLE TO
FACTORING
? Factoring transactions in India are governed by the
following Acts:-
a) Indian Contract Act
b) Sale of Goods Act
c) Transfer of Property Act
d) Banking Regulation Act.
e) Foreign Exchange Regulation Act.
FORFAITING
? Forfait is derived from French word „A Forfait?
which means surrender of rights.
? Forefaiting is a mechanism by which the right for
export receivables of an exporter (Client) is
purchased by a Financial Intermediary (Forfaiter)
without recourse to him.
?It is different from International Factoring in as
much as it deals with receivables relating to
deferred payment exports, while Factoring deals
with short term receivables.
FORFAITING (CONTD…)
?Exporter under Forfaiting surrenders his right
for claiming payment for services rendered or
goods supplied to Importer in favour of
Forefaiter.
?Bank (Forefaiter) assume default risk possessed
by the Importer.
?Credit Sale gets converted as Cash Sale.
?Forfaiting is arrangement without recourse to
the Exporter (seller)
FORFAITING (CONTD…)
?Fee charge by forfaiter
? Commitment fee-0.5-1.5 %
? Discount fee-LIBOR+PREMIUM
? Documentation fee
?Finance available up to 100% of value (unlike in
Factoring)
?Introduced in the country in 1992.
?In India it was introduced in January, 1994.
?In India, forfaiting is done by the EXIM bank.
MECHANICS OF FORFAITING
EXPORTER
IMPORTER
FORFAITER
AVAILLING BANK
HELD TILL MATURITY
SELL TO GROUPS OF INVESTORS
TRADE IN SECONDARY MARKET
ESSENTIAL REQUISITES OF FORFAITING
TRANSACTIONS
?Exporter to extend credit to Customers for
periods above 6 months.
?Exporter to raise Bill of Exchange covering
deferred receivables from 6 months to 5 years.
?Repayment of debts will have to be avallised or
guaranteed by another Bank, unless the Exporter
is a Government Agency or a Multi National
Company.
FACTORING VS. FORFAITING
?Factoring refers to domestic transaction whereas
forfaiting refers to international trade.
?No letter of credit or bank guarantee is required
but incase of forfaiting LC/BG is required.
?Forfaiter discounts the entire value – 100 %
finance where as a Factor – 75-80%
?Forfaiting is done without recourse to the client
whereas it may or may not be so under factoring.
?No restriction on minimum size of transaction
whereas the minimum value of $2.5 lakh per
transaction in forfaiting.
?Factoring is short-term finance whereas forfaiting
finances notes/bills arising out of deferred credit
transactions spread over 3 years
?Forfaiting is pure financial arrangement –
Factoring includes ledger administration,
collection, advise etc.
?A factor does not guard against exchange rate
fluctuations, whereas forfaiter charges a
premium for such risk
WHY FORFAITING HAS NOT DEVELOPED
? Relatively new concept in India.
? Depreciating Rupee
? High minimum cost of transactions (USD 2.5 Lakhs)
? RBI Guidelines are vague.
? Very few institutions offer the services in India.
Exim Bank alone does.
? Long term advances are not favoured by Banks as
hedging becomes difficult.
? Lack of awareness.
doc_997448953.ppt
In addition to debt and equity financing, leasing has emerged as a third important source of intermediate long-term financing, Prior to 1950, leasing was primarily concerned with real estate i.e., Land & building.
LEASING
INTRODUCTION & ORIGINATION
? The main objective of any business is to maximize the
owner?s economic welfare by EXPANDING,
DIVERSIFYING ACTIVITIES.
? In addition to debt and equity financing, leasing has
emerged as a third important source of intermediate long-
term financing.
? Prior to 1950, leasing was primarily concerned with real
estate i.e., Land & building.
CONTINUED….
?In 1973 the concept was introduced by First
Leasing Company of India Ltd.
?Then some public & private sector players
were involving in lease financing like ICICI &
GIC.
MEANING
? It is an arrangement that provides a firm with the use &
control over assets without buying and owning the same.
? It is a form of renting assets.
? It is a contract between the owner of the asset (lessor) & the
user of the asset called lessee, whereby the lessor gives the
right to use the asset to the lessee over an agreed period of
time for a consideration called the lease rental.
DEFINITION
?“Lease is a form of contract transferring the use
or occupancy of land, space, structure or
equipment, in consideration of a payment,
usually in the form of a rent.”
?Lease rental may be payable at the beginning or
end of a month, quarter, half-year or year.
?There is option to buy or renew the lease
ESSENTIAL ELEMENTS OF LEASING
?No. of parties to the contract
?Asset/Property/Equipment
?Consideration(lease rentals)
?Lease period
?Termination of contract
WHY LEASING ?
? A flexible investment instrument;
? A way of broadening the financing options available
to local companies;
? An efficient way to finance investment in capital
assets by new companies;
? Attractive for financing small and medium
enterprises.
TYPES OF LEASE AGREEMENTS
?Operating/Service Lease.
?Financial Lease.
?Leverage Lease.
?Sale & Leaseback.
?Cross Border Lease.
OPERATING LEASE
? It is a short-term lease on a period to period basis. The
lease period in such a contract is less than the useful life of
the asset.
? The lease is usually cancellable at a short notice by the
lessee.
? The lessee usually has the option of renewing the lease
after the expiry of lease period.
? The lessor is responsible for maintenance, insurance &
taxes of the asset.
? Higher risk to lessor & higher rental to lessee.
? Example: Computers, Vehicles.
FINANCIAL LEASE
? Long-term & non-cancellable in nature.
? Alternative to debt financing and assets are concerned like
land, building, machinery.
? Lessor recovers his investments along with an acceptable
rate of return.
? Lessee is responsible for the maintenance, insurance, and
service of the asset.
? Renewal or buying option attached.
? Examples: Machine Tools, Textile Machinery, Containers,
Locomotives etc.
LEVERAGED LEASE
? It is an arrangement under which the lessor borrows funds
for purchasing the asset, from a third party called lender
(Bank/Finance co.).
? The loan is secured by the mortgage of the asset.
? Lease rentals to be received from the lessee and excess
amounts remitted to the lessor.
? Example: Coal Mining, Pipe lines, Ships, Electricity
Generating Plants etc.
SALE & LEASEBACK
? The firm Which has an asset sells it to the leasing
company and gets it back on lease & makes periodical
rental payments.
? It is suitable for the firms facing shortage of working
capital funds.
? Chances of repurchase in some cases.
? Example: Retail stores/Shopping Centres, Office
Building.
CROSS BORDER LEASE
?It is an international leasing and both parties
are not belonging to the same country.
?Example: USA makes available an Airbus to
Air india.
TAX IMPLICATION
? Lessee can deduct lease payments for income tax purposes.
CONDITIONS
? Must be used for business purposes and not to avoid
taxes.
? Should not include an option to acquire the asset at the
end of the lease at a below market price.
? Lease payments should not start high and then drop
dramatically.
? Renewal options must be reasonable and consider fair
market value at the time of the renewal
ADVANTAGES OF LEASING
Advantages to the Lessee
? Avoidance of Initial Cash Outlay.
? Minimum Delay.
? Easy Source of Finance.
? Shifting the risk of Obsolescence .
? Enhance Liquidity.
? Tax Advantage.
? Flexibility & Convenience.
? No Floatation Cost.
ADVANTAGES OF LEASING
Advantages to the Lessor
? Higher Profits
? Tax Benefits (Depreciation & Investment Allowance)
? Quick Returns
? Increased Sales of leased assets
HIREPURCHASE-MEANING
? It means a transaction where goods are purchased
and sold on the following terms that:
? Payment will be made in installments.
? Possession of goods transferred immediately.
? Ownership remains with the seller.
? Seller can repossess in case of default.
? Each installments are treated as hire charges.
DEFINITION
? The hire purchase act, 1972 defines a HP agreements as
“an agreements under which goods are let on hire and
under which the hirer has an option to purchase them in
accordance with the terms of the agreement & includes
an agreement under which:
? Transfer of possessions & periodical payments.
? Ownership transferred on payment of last installment
? Hire purchaser has a right to terminate the agreement.
DIFFERENCE BETWEEN HP &
INSTALLMENT PURCHASE
? Actual Sale
? Legal Ownership
? Right to sale
? Legal protection
? Rights of seller
? Bad Debt
LEASE OR BUY DECISION
? The cost of leasing the asset should be compared with
cost of financing the asset through normal source of
financing i.e., debt or equity.
? Calculate the present value of net cash flow of the buying
option called NPV(B).
? Calculate present value of net cash outflow of the leasing
option called NPV(L),
? If NPV(B)< NPV(L)-BUY
? If NPV(L)< NPV(B)-LEASE
* Fresh Water Drilling Company needs an additional drilling
Machine at the cost of Rs. 15 lakhs for sinking bore wells. At
present, it can not spare its own funds to buy the equipment. The
company has to either borrow funds from the bank or taken on lease
the equipment for five years.
* The bank charges 15 per cent interest rate & the instalments can
be paid at the year end for the stipulated lease of five years.
* The salvage value is Rs. 1.5 lakhs.
* In the case of leasing, a rent of Rs. 4.95 lakhs is charged at the
end of the year.
* The rate of depreciation allowed on the equipment is 15 % on
diminishing balance method.
?The company has to pay income tax @ 50 per cent and has a
discounting rate of 14 per cent.
Evaluate the two options and give your suggestions excluding
capital loss on sale of machine.
BORROW AND PURCHASE OPTION (RS.
IN ,000)
Year
(1)
Principal
Repayment
(2)
Interest at
15 %
(3)
Depreciatio
n
(4)
Tax Shield
(3+4)x50 %
(5)
Net Cash
Outflow
(2+3)-(5)
(6)
PV
14 %
(8)
Discounted
Cash
Outflow
(9)
1
2
3
4
5
Les
s
300
300
300
300
300
PV of
225
180
135
90
45
Salvage
Value of
asset
225
191.25
162.56
138.18
117.45
225
185.63
148.78
114.09
81.23
300
294.37
286.22
275.90
263.78
(150)X
(0.519)
0.877
0.769
0.675
0.592
0.519
263.10
226.37
193.20
163.34
136.90
982.91
-77.85
905.06
SCHEDULE OF DEPRECIATION
RS. IN,000
Year Depreciation
Balance at the
End of the year
1 1500x015= 225
1275
2 1275x0.15=191.25
1083.75
3 1083.75x0.15=162.56
921.19
4 921.19x0.15=138.18
783.01
5 783.01x0.15=117.45
665.56
LEASE OPTION (RS.
IN ,000)
Year Lease
Rentals
Tax Shield
50 % of (2)
Net Cash
Outflow (2)-(3)
PV Factor
14 %
Discounte
d Cash
Outflow
(1) (2) (3) (4) (5) (6)
1-5 495 247.5 247.50 3.433 849.67
Lease option is more profitable for the company because the
cash outflow under leasing (849.67) is lesser than borrowing
& purchasing (905.06) option
CASE STUDY 2
?XYZ Ltd. is in the business of manufacturing a product A. The firm
is planning to diversify and add a new product line in the firm either
by purchasing the required machinery or get it on lease.
? The cost of the machinery is Rs.15 lakh and its expected useful
life is 5 years with scrape value of Rs.1 lakh. The machinery can be
financed by loan @ 20% interest p.a. repayable in 5 annual
installments inclusive of interest being due at the end of each year.
? Alternatively the machine can be taken on year end lease rental of
Rs.4.5 lakh for five years. Rate of depreciation is 25% p.a. & method
to be followed is WDV. Tax rate is 35%. Maintenance expenses is
Rs.30000 per year are to be borne by lessee. Advice the company
whether to buy or lease.
PRESENT VALUE OF CASH OUTFLOW UNDER LEASING
RS
Year end Lease Rent after taxes
Lease Rental*(1-t)
450000*(1- 0.35)
PVIFA@13%
Interest*(1-t)
20%*(1-0.35)
PV OF Cash
Outflow
1 to 5 292500 3.517 1028723
PV OF CASH OUTFLOW UNDER BUYING
Year
end
Loan
Installmen
t
Tax
advantage
on Interest
Tax
advantage
on
Depreciation
Net Cash
Out flow
PVIF
@13%
PV of
Cash
Outflow
1
501505 105000 131250 265255 0.885 234751
2
501505 90895 98437 312173 0.783 244431
3
501505 73968 73828 353709 0.693 245120
4
501505 53656 55371 392478 0.613 140589
5
501505 29114 41528 430863 0.543 233959
Total
LESS: PV
OF SCRAP
100000*0.543
54300
1198850
LESS: PV of
Tax saving
on capital
loss
(355958-
100000)*0.35*0
.543
48645
Cash
outflo
w
102945
1095905
SCHEDULE OF DEBT PAYMENT
Year end
Loan
installment
Loan at begin
of the year
Interest
Payments
Principal
Payments
Loan
Outstanding
at the end of
the year
1 501505 1500000 300000 201505 1298495
2 501505 1298495 259699 241806 1056689
3 501505 1056689 211338 290167 766522
4 501505 766522 153304 348201 418321
5 501505 418321 83184* 418321 0
EAI = Rs.1500000/2.991 (PVIFA for five years at 20%) =Rs.501505
SCHEDULE OF DEPRECIATION
Year Depreciation Balance
1 1500000*0.25=375000 1125000
2 1125000*0.25=281250 843750
3 843750*0.25=210937 632813
4 632813*0.25=158203 474610
5 474610*0.25=118652 355958
Suggestion: The Company should lease the asset because the cash outflow in
lease option is less than buying option.
FACTORING-ORIGIN
Factoring services started in US in early 1920s and were
introduced to other parts in 1960s
Kalyana Sundaram Committee recommended introduction
of factoring in 1989.
Banking Regulation Act, 1949, was amended in 1991 for
Banks setting up factoring services.
SBI/ Canara Bank have set up their Factoring
Subsidiaries:-
?SBI Factors Ltd., (April, 1991)
?CanBank Factors Ltd., (August, 1991).
FACTORING
Factoring is the Sale of Book Debts by a firm (Client) to a
financial institution (Factor) on the understanding that
the Factor will pay for the Book Debts as and when they
are collected or on a guaranteed payment date.
Normally, the Factor makes a part payment (usually up to
80%) immediately after the debts are purchased thereby
providing immediate liquidity to the Client.
FACTORING SERVICES - CONCEPT
Client
Customer
Factor
Order placed
Deliver of goods
Client submits
invoice
Factor-Prepayment
Monthly statements
Customer pays
PROCESS INVOLVED IN FACTORING
? Client concludes a credit sale with a customer.
? Client sells the customer’s account to the Factor and notifies the
customer.
? Factor makes part payment (advance) against account purchased,
after adjusting for commission and interest on the advance.
? Factor maintains the customer’s account and follows up for
payment.
? Customer remits the amount due to the Factor.
? Factor makes the final payment to the Client when the account is
collected or on the guaranteed payment date.
SERVICES/FUNCTIONS OFFERED BY A FACTOR
? Follow-up and collection of Receivables from Clients.
? Sales ledger management.
? Purchase of Receivables with or without recourse.
? Help in getting information and credit line on
customers (credit protection)
? Sorting out disputes, if any, due to his relationship with
Buyer & Seller.
TYPES OF FACTORING
? Disclosed & Undisclosed Factoring
? Recourse Factoring
? Non-recourse Factoring
? Advance & Maturity Factoring
? Cross-border Factoring
DISCLOSED & UNDISCLOSED FACTORING
? In case of disclosed factor the name of the
proposed factor is mentioned on the face of the
invoice made out by the seller of goods.
? Under undisclosed factor the name of the proposed
factor finds no mention on the invoice made by the
seller. Although, the control remains with the factor.
RECOURSE FACTORING
?Factor purchases Receivables on the condition that loss
arising on account of non-recovery will be borne by the
Client.
?Credit Risk is with the Client.
?Factor does not participate in the credit sanction process.
?In India, factoring is done with recourse.
NON-RECOURSE FACTORING
?Factor purchases Receivables on the condition that loss
arising on account of non-recovery will be borne by the
factor.
?Credit risk is with the Factor.
?Higher commission is charged.
?Factor participates in credit sanction process and
approves credit limit given by the Client to the Customer.
?In USA/UK, factoring is commonly done without
recourse.
ADVANCE FACTORING
?The factor makes an advance payment in
the range between 70-80 per cent.
?Factor collects interest on the advance
payment from the client.
MATURITY FACTORING
?Factor does not make any advance payment to the
Client.
?Pays on guaranteed payment date or on collection of
Receivables.
?Guaranteed payment date is usually fixed taking into
account previous collection experience of the Client.
?Nominal Commission is charged.
?No risk to Factor.
CROSS - BORDER FACTORING
? It is similar to domestic factoring except that there are four parties, viz.,
a) Exporter,
b) Export Factor,
c) Import Factor, and
d) Importer.
? It is also called two-factor system of factoring.
? Exporter (Client) enters into factoring arrangement with Export Factor in
his country and assigns to him export receivables.
? Export Factor enters into arrangement with Import Factor and has
arrangement for credit evaluation & collection of payment for an agreed
fee.
? Notation is made on the invoice that importer has to make payment to
the Import Factor.
? Import Factor collects payment and remits to Export Factor who passes
on the proceeds to the Exporter after adjusting his advance, if any.
? Where foreign currency is involved, Factor covers exchange risk also.
Exporter Importer
Country A Country B
Export Factor
Import Factor
Goods and invoices – Stage I
Copy Invoice Stage II
Prepayments Stage III
Copy Invoices Stage IV
Statements Stage V
Payments
Stage VI
Payments Stage VII
Payment of Commission Stage VIII
STATUTES APPLICABLE TO
FACTORING
? Factoring transactions in India are governed by the
following Acts:-
a) Indian Contract Act
b) Sale of Goods Act
c) Transfer of Property Act
d) Banking Regulation Act.
e) Foreign Exchange Regulation Act.
FORFAITING
? Forfait is derived from French word „A Forfait?
which means surrender of rights.
? Forefaiting is a mechanism by which the right for
export receivables of an exporter (Client) is
purchased by a Financial Intermediary (Forfaiter)
without recourse to him.
?It is different from International Factoring in as
much as it deals with receivables relating to
deferred payment exports, while Factoring deals
with short term receivables.
FORFAITING (CONTD…)
?Exporter under Forfaiting surrenders his right
for claiming payment for services rendered or
goods supplied to Importer in favour of
Forefaiter.
?Bank (Forefaiter) assume default risk possessed
by the Importer.
?Credit Sale gets converted as Cash Sale.
?Forfaiting is arrangement without recourse to
the Exporter (seller)
FORFAITING (CONTD…)
?Fee charge by forfaiter
? Commitment fee-0.5-1.5 %
? Discount fee-LIBOR+PREMIUM
? Documentation fee
?Finance available up to 100% of value (unlike in
Factoring)
?Introduced in the country in 1992.
?In India it was introduced in January, 1994.
?In India, forfaiting is done by the EXIM bank.
MECHANICS OF FORFAITING
EXPORTER
IMPORTER
FORFAITER
AVAILLING BANK
HELD TILL MATURITY
SELL TO GROUPS OF INVESTORS
TRADE IN SECONDARY MARKET
ESSENTIAL REQUISITES OF FORFAITING
TRANSACTIONS
?Exporter to extend credit to Customers for
periods above 6 months.
?Exporter to raise Bill of Exchange covering
deferred receivables from 6 months to 5 years.
?Repayment of debts will have to be avallised or
guaranteed by another Bank, unless the Exporter
is a Government Agency or a Multi National
Company.
FACTORING VS. FORFAITING
?Factoring refers to domestic transaction whereas
forfaiting refers to international trade.
?No letter of credit or bank guarantee is required
but incase of forfaiting LC/BG is required.
?Forfaiter discounts the entire value – 100 %
finance where as a Factor – 75-80%
?Forfaiting is done without recourse to the client
whereas it may or may not be so under factoring.
?No restriction on minimum size of transaction
whereas the minimum value of $2.5 lakh per
transaction in forfaiting.
?Factoring is short-term finance whereas forfaiting
finances notes/bills arising out of deferred credit
transactions spread over 3 years
?Forfaiting is pure financial arrangement –
Factoring includes ledger administration,
collection, advise etc.
?A factor does not guard against exchange rate
fluctuations, whereas forfaiter charges a
premium for such risk
WHY FORFAITING HAS NOT DEVELOPED
? Relatively new concept in India.
? Depreciating Rupee
? High minimum cost of transactions (USD 2.5 Lakhs)
? RBI Guidelines are vague.
? Very few institutions offer the services in India.
Exim Bank alone does.
? Long term advances are not favoured by Banks as
hedging becomes difficult.
? Lack of awareness.
doc_997448953.ppt