What is Documentary Collection and Factoring?

Documentary Collection

The principal or seller or exporter or drawer of draft prepares the “collection order” that indicates the terms and conditions.

The remitting bank (“exporter’s bank”) collect the shipping documents from the exporter and forward them to the presenting or collecting bank (“importer’s bank or drawee’s bank”).

Documents against Payment (D/P) or sight draft or CAD “Cash Against Documents”: The importer pays immediately in exchange for the shipping documents.

Documents against Acceptance (D/A) or time draft: The importer will agree to pay at a later date which might be 30 or 60 or 90 days after presentment to buyer, in exchange for documents.

Unlike documentary credits (letters of credit), in documentary collections, there is no guarantee of payment by the banks as the latter are just intermediaries. Documentary collections cost less than documentary credits (letters of credit).

Factoring

A company can sell its individual accounts to a factor so to generate cash immediately. A factor is a financial establishment that receives a service fee for that. The amount of service fee is based on the risk being involved. With recourse is lower service fee than without a recourse (the factor assumes the risk).

Example

The exporter sells goods to importer and hence a receivable is created. The exporter sells the receivable to a factor to get cash. The importer pays the receivable to the factor.

XYZ company sells $ 100,000 (payable in 30 days) of accounts receivable to ABC factor.

Let us say that ABC charges 5% factoring fee and 10 % interest fees. Let us also say that ABC advances 70 % payment.

Then XYZ will receive $ 70,000 as first payment.

ABC will receive as interest fee: $ 70,000 x 0.1 x 30/365 = around $ 575

ABC will receive as factoring fee: $ 100,000 x 0.05 = $ 5000

Rest paid to XYZ will be: $ 24425

Selected References:

Hinkelman, E. (2003). A Short course in international payments: How to use letters of credit, (D/P) and (D/A) terms, prepayment, credit and cyberpayments in international transactions. USA: World Trade Press.

Wahlen, J.M., & Jones, J.P. & Pagach, D. (2015). Intermediate accounting: Reporting and analysis. Cengage Learning.