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(^370) Financial Management
Pledging of receivables can be either on a notification or non-notification basis. On a
notification basis the borrower notifies its accounts that payments on the receivables
are to be made directly to the lender. On a non-notification basis the account is not
informed of the financial arrangements between borrower and lender. The account
remits payments to the borrower, who forwards is to the lender. The lender then checks
the payment against the schedule provided by the borrower and reduces the borrowerís
loan balance by a corresponding amount. When pledging receivables is on a non-
notification basis, the lender relies on the borrower to forward account payments to
him. Should the borrower keep the checks, the lender would be ultimately holding
ìreceivablesî that have been paid. To prevent fraud of this natures, non-notification
pledging allows the lender to randomly audit the borrowerís books to see that payments
on all pledged accounts are being forwarded to the lender.
The lender will also adjust the rupee value of accounts pledged for any discrepancies
between the amount invoiced and the amount paid. These discrepancies are caused by
the account taking a cash discount for early payment, taking credit for merchandise
returned or adjusting for other invoice errors.
Interest Rates. Interest rates with pledged receivables financing are 2 to 4 per cent
higher than the prime-lending rate. The lending institution may also charge a processing
fee, which may equal 1 to 3 per cent of the average annual loan. Commercial finance
companies charge rates that are higher than the rates charged by banks. The total
effective interest with this type of receivables financing will vary from 10 to 20 per
cent. This high interest rate does not imply that secured loans are more expensive than
unsecured loans. The rates are high because the borrower is risky and does not have
access to normal sources of unsecured loans.
Factoring
Factoring is an arrangement between the company and the factor (another company
providing factoring services) in which the factor agrees to buy the bills receivable of
the company for a commission and an interest for the period for which he is expected
to keep the bills before receiving payments from the parties on whom the bill is drawn.
Factoring can be on recourse basis (in which the risk of default is borne by the company)
or without recourse (in which the risk of default is borne by the factor himself). The
biggest benefit of factoring is that the receivables can be converted into cash and
redeployed into the business. The most negative aspect is that the interest rate is higher
than most other short-term debt instruments because it depends upon the quality of the
parties on which the bills are drawn (except ICDs where it is equivalent). Hence company
going in for factoring is looked down upon considering the fact that the company was