Balance Sheet: Post Factoring Scenario
The impact of factoring on the balance sheet as revealed by Tables is three fold.
Off balance Sheet Financing
As the client’s debts are purchased by the factor, the finance provided by him is off the balance sheet and appears in the balance sheet only is a contingent liability in the case of recourse factoring. In case of non recourse factoring it does not appear anywhere in the financial statements of the borrower. The prepayment of Rs 64 lakh made by the factor goes off the balance sheet getting converted into cash, leaving the balance of Rs 16 lakh in the balance sheet as due from the factor.
Reduction or Current Liabilities
From the factoring proceeds of Rs 64 lakh, the bank borrowings are liquidated to the extent of Rs 10 lakh. The balance of Rs 24 lakh can be used by the client for paying off other current liabilities comprising of trade creditors for goods and Services. creditors for expenses. loan instalments payable statutory liabilities and provisions. The client may meet any of these obligations with the balance of Rs 24 lakh. The net effect is to reduce current liabilities by Rs 64 lakh.
Improvement in Current Ratio
As the factoring transaction is off the balance sheet, it removes from the asset side the receivables factored to the extent of the prepayment made and on the liabilities side the current liabilities are also reduced. The result is a desirable improvement in the current ratio from 1.33:1 to 1.58:1.
In brief, the effect of factoring is to improve the financial discipline of the firm.