Elements of

Financial Services
Unit 2
Fund based:
 Leasing
 Hire purchasing
 Factoring
 Forfaiting etc.
Leasing:
 The periodical payment made by the lessee to
the lessor is known as lease rental. Under lease
financing, lessee is given the right to use the
asset but the ownership lies with the lessor and
at the end of the lease contract, the asset is
returned to the lessor or an option is given to
the lessee either to purchase the asset or to
renew the lease agreement.
Leasing:

 A lease is a contract which explains the terms

under which one party agrees to provide his
property to a rentor.
 The owner is known as lessor
 The rentor is known as lessee
 Lessor gets a regular payment for a specified
number of years but the possession rests with
the lessee.
Features of Lease Contract:

 The lease finance is a contract.

 The parties to contract are lessor and lessee.
  Equipment are bought by lessor at the request
of lessee.
 The lease contract specifies the period of
contract.
 The lessee uses these equipment’s.
 The lessee, in consideration, pays the lease
rentals to the lessor
  The lessor is the owner of the assets and is
entitled to the benefit of depreciation and
other allied benefits e.g., under sections 32A
and 32B of the Income-tax Act.
 The lessee claims the rentals as expenses
chargeable to his income.
Types of lease:

 Financial Lease:
 A lease is considered as a financial lease if the
lessor intends to recover his capital outlay plus
the required rate of return on funds during the
period of lease.
 It is a form of financing the assets under the cover
of lease transaction.
 In this type of leases, lessee will use and have
control over the asset without holding the title to
it.
 The lessee acquires most of the economic values
associated with the outright ownership of the
asset.
 The lessee is expected to pay for upkeep and
maintenance of the asset.
 This is also known by the name ‘capital lease.
 The essential point of this type of lease
agreement is that it contains a condition whereby
the lessor agrees to transfer the title for the asset
at the end of the lease period at a nominal cost.
 At the end of lease it must give an option to the lessee to
purchase the asset he has used at the expiry of the lease.
 Under this lease usually 90% of the fair value of the asset
is recovered by the lessor as lease rentals and the lease
period is 75% of the economic life of the asset.
 The lease agreement is irrevocable.
 Practically all the risks incidental to the asset ownership
and all the benefits arising therefrom is transferred to the
lessee who bears the cost of maintenance, insurance and
repairs.
 Only the title deeds remain with the lessor.
Suitability:
  When the lessee wants to own the asset but
does not have enough funds to invest.
 The time period to use the asset is
substantially long at lower lease rentals.
Operating Lease:

 An operating lease is similar to the financial lease

in almost all aspects.
 This lease agreement gives to the lessee only a
limited right to use the asset.
 The operating lease is generally for a short-term,
where the lessor is usually the manufacturer of the
asset, who want to increase his sales by allowing
the customers to pay in installments for a short-
term and ultimately the title to the asset will be
transferred to the lessee on making full payment.
 In some cases the lessor keeps the title to the goods
and he continues to lease the asset to other party until
the life of the asset is completed.
 In the operating lease, it is the responsibility of the
lessee to maintain and upkeep the asset properly when
the asset is under his control.
 The lessor will enjoy the depreciation claim and the
lessee will show his lease rentals and asset maintenance
expenses as business expenditure.
 At the end of the life of the asset, it will be sold off by
the lessor to get the salvage value.
Suitability:

 When the long-term suitability of asset is

uncertain.
 When the asset is subject to rapid
obsolescence.
 When the asset is required for immediate use
to tie over a temporary problem.
Sale and Lease Back:

 Under this the lessee first purchases the equipment

of his choice and then sells it to the lessor firm.
 The lessor in turn leases out the asset to the same
lessee.
 The advantage of this method is that the lessee can
satisfy himself completely regarding the quality of
the asset and after possession of the asset convert
the sale into a lease arrangement.
 This option he can exercise even in the case of an old
asset used by him for some time to get the release of
a lump-sum cash which he can put into alternative
use.
 This method of financing an asset is also
popular when the lessee is in liquidity
problems, he can sell the asset to a leasing
company and takes it back on lease.
 This will improve the liquidity position of the
lessee and will continue to use the asset
without parting with it.
Leveraged Lease:
 In this form of lease agreement, the lessor undertakes to finance
only a part of the money required to purchase the asset.
 The major part of the finance is arranged with a financier to
whom the title deeds for the asset as well as the lease retails are
assigned.
 There are usually three parties involved, the lessor, the lessee
and the financier.
 The lease agreement is between the lessee and lessor as in any
other case. But it is supplemented by another separate
agreement between the lessor and the financier who agrees to
provide a major part (say 75%) of the money required.
 This is a type of lease agreement which will enable the lessor to
undertake an expand volume of lease business with a limited
amount of capital and hence it is named leverage leasing.
Sales Aid Leasing:

 A leasing company will enter into an

agreement with the seller, usually
manufacturer of the equipment, to market
the latter’s product through its leasing
operations.
 The leasing company will also get
commission for such sales, which add up to its
profits.
Structure of Lease Rentals:

 The lease rentals are payable on periodical basis

over the specified lease period.
 The lease rentals should be structured in such a way
that it will be convenient for both lessor and lessee.
 In a competitive situation, the lessee will tend to
obtain lease finance where the lease rentals are
lowest.
 The lessor has to recover his principal amount
invested as well as the desired return on
investment.
Lease rent structure may be in
the following ways:
 Equal Annual Plan:In this plan, the annual
lease rent payable is divided into equal
amounts by applying the annuity factor for
the specified period of lease at a
predetermined interest rate taken as discount
rate.
  Stepped-Up Plan:Under this plan, the
annual lease rent will go on increasing every
year with a specified rate of increase.
 Balloon Payment Plan:In this plan, the
annual lease rent payable in the initial year
would be less, fixed up in such a way to meet
the nominal amount comparative to the cost
of investment, but the ending years of lease
periods, the rest of the amount is payable in
lump sum.
Deferred Payment Plan:

 Under this plan, the lease rent need not be

paid for the initial specified period. But lease
rent payable in the subsequent period, in
equal annual amounts will recover the cost of
financing for the deferred payment period
also.
Importance of lease financing:
 Lease finance is easy to get than getting loan
for buying all fixed assets. 
 Monthly rent payment for lease finance will
be operating expenses. It will be allowed to
deduct total income. So, company can get tax
benefits in lease financing.
 One of major important point is that it is
more flexible way of finance.    
 Advantages to lessor:

 Assured Regular Income

 Preservation of ownership
 High profitability
 Recovery of investment
To lessee:

 Use of capital goods

 Tax benefits
 Cheaper
 Technical assistance
 No effect of inflation
 Ownership
Other advantages:

 Liquidity
 Convenience
 Hidden Liability
 Time Saving
 No Risk of Obsolescence
 Cost Saving
 Flexibility
Disadvantages to lessor:

 Loss at inflation
 Chances of damage
To lessee:
Compulsion
Ownership
Costly
Understatement of asset
Hire purchasing:

 Hire purchase is a method of financing of the

fixed asset to be purchased on future date.
Under this method of financing, the purchase
price is paid in installments. Ownership of the
asset is transferred after the payment of the
last installment.
Features:

 The hire purchaser becomes the owner of the

asset after paying the last installments.
 Every installment is treated as hire charge for
using the asset.
 Hire purchaser can use the asset right after
making the agreement with the hire vendor.
 The hire vendor has the right to repossess the
asset in case of difficulties in obtaining the
payment of installment.
Advantages of Hire Purchase:

 Financing of an asset through hire purchase is

very easy.
 ii. Hire purchaser becomes the owner of the
asset in future.
 iii. Hire purchaser gets the benefit of
depreciation on asset hired by him/her.
Disadvantages of Hire
Purchase:
  Ownership of asset is transferred only after
the payment of the last installment.
 ii. The magnitude of funds involved in hire
purchase are very small and only small types
of assets like office equipment’s,
automobiles, etc., are purchased through it.
 iii. The cost of financing through hire
purchase is very high.
Factoring:
 Factoring is a continuous arrangement between a
financial intermediary called a factor and a seller
called client of goods and services.
 Based on the type of factoring,the factor performs
the services in respect of the accounts receivables
arising from the sale of such goods and services.
 Purchases all A/R of the seller for immediate cash.
 Administers the sales ledger of seller
 Collects the A/R
 Assumes the losses which may arise from bad debts
 Provides relevant advisory services to the seller.
Types of factoring:

 Recourse factoring:under recourse

factoring,the factor purchases the receivables
on the condition that any los arising out of
irrecoverable receivables will be borne by the
client.
 Non-recourse or full factoring:the factor has
no recourse to the client if the receivables are
not covered.
Types of factoring:

 Maturity factoring:the factor does not make any advance

payment or pre pyment.
 Invoice discounting:the factor provides a pre payment to
the client against the purchase of A/R and collects interest
for the period extending from the date of pre payment to
the date of collection.
  Advance Factoring
 This could be with or without recourse. Under this
arrangement, the Factor provides advance at an agreed
rate of interest to the client on uncollected and non-due
receivables. This is only a pre-payment and not an advance.
 Under this method, the customer is not
notified about the arrangement between the
client and the Factor. Hence the buyer is
unaware of factoring arrangement. Debt col­
lection is organized by the client who makes
payment of each invoice to the Factor, if ad­
vance payment had been received earlier.
Bulk Factoring

 It is a modified version of Involve discounting

wherein notification of assignment of debts is given
to the customers. However, the client is subject to
full recourse and he carries out his own
administration and collection.
  Agency Factoring
 Under this arrangement, the facilities of finance and
protection against bad debts are provided by the
Factor whereas the sales ledger administration and
collection of debts are carried out by the client.
 Disclosed and Undisclosed Factoring: The
factoring in which the factor’s name is indicated in
the invoice by the supplier of the goods or services
asking the purchaser to pay the factor, is called
disclosed factoring.Conversely, the form of
factoring in which the name of the factor is not
mentioned in the invoice issued by the
manufacturer. In such a case, the factor maintains
sales ledger of the client and the debt is realized in
the name of the firm. However, the control is in the
hands of the factor.
 Domestic and Export Factoring: When the
three parties to factoring, i.e. customer, client,
and factor, reside in the same country, then
this is called as domestic factoring.Export
factoring, or otherwise known as cross-border
factoring is one in which there are four parties
involved, i.e. exporter (client), the importer
(customer), export factor and import factor.
This is also termed as the two-factor system.
Supplier gurantee factoring:

 When client is a mediator between supplier and

customer. The factor gurantees the supplier for the
shipment of goods on behalf of client.
 , the role of factor involves taking guarantee of the
business. The factor guarantees the payment of the
suppliers of the business and on the other side takes
factors the invoices of the business. Once the money
is realized from the invoices, the factor first makes
payment to the suppliers of the business and then the
remain portion of the business after cutting
necessary fee for the same.
 BANK PARTICIPATION FACTORING
 This is a special arrangement whereby the
margin of a factor is also financed by the bank.
This is most suitable for the business for whom
even the small margin of money is important.
This kind of factoring arrangement allows the
business to have complete finance of the
account receivables and needs almost no
money to conduct business.
Table:
Types/ Short term Sales ledger Credit
service finance administrati protection
on
Recourse yes yes No
factoring
Non recourse Yes yes Yes
factoring
Maturity No Yes No
fatoring
Invoice yes No no
discounting
Process:
 Borrowing company or the client sells the book debts to the lending
institution (factor).
 Factor acquires the receivables and extend money against the receivables,
after deducting and retaining the following sum, i.e. an adequate margin,
factor’s commission and interest on advance
 Collection from the customer is forwarded by the client to the factor and in
this way, the advance is settled.
 Other services are also provided by the factor which includes:
 Finance
 Collection of debts
 Maintenance of debts
 Protection of Credit Risk
 Maintenance of debtors ledger
 Debtors follow-up
 Advisory services
 The factor gets control over the client’s debtors, to whom the goods are sold
on credit or credit is extended and also monitors the client’s sales ledger.
Functions:

 Maintenance of sales ledger

 Collection of accounts receivables
 Credit controland credit protection
 Advisory functions
Steps:

 Customer places an order with client

 Agreement of contract between factor and client
 Sale contract is entered into with the buyer and the goods
are delivered. The invoice with the notice to pay the factor
is sent along with.
 Copy of invoice is sent to factor
 Factor prepays 80% of invoice value
 Monthly statements are sent to buyer by factor
 If unpaid invoices follow up is done
 Remaining amount to be paid to seller (settlement of total
amount).
Forfaiting:

 It means financing exporters in its exported

items.
 Enables to receive immediate cash by selling
their medium and long term receivables at a
discount.
 Normally non –recourse forfaiting is dealt
with.
 Forfaiter is basically the bank
Advantages:

 Less time consuming

 No credit risk
 Concentrate on other imp. issues
Disadvantages;

 High cost/expensive
 Can sell out only if amount exceeds $1lakh.
basis factoring Forfaiting
Meaning Factoring is an Forfaiting implies a
arrangement that transaction in which the
converts your receivables forfaiter purchases
into ready cash and you claims from the exporter
don't need to wait for the in return for cash
payment of receivables payment.
at a future date.
Maturity of receivables Short term Medium to long term
Goods Ordinary goods Capital goods
Finance 80-90% 100%
Type Recourse or non- Non-recourse
recourse
Cost Borne by seller Borne by overseas buyer
Secondary market no Yes
Negotiable instrument No negotiable Negotiable instrument
instrument
Process 

  Exporter initiates negotiations with prospective

overseas buyer, finalizes the contract and the importer
opens an LC through his Bank in favor of the seller
(exporter).
 Exporter Ships the goods as per the schedule agreed
with the buyer.
 The exporter draws a series of bills of exchange and
sends them along with the shipping documents, to his
banker for presentation to importer for acceptance
through latter’s bank. Bank returns avalised and
accepted bills of exchange to his client (the exporter).
Process 

 Exporter informs the Importers Bank about assignment

of proceeds of transaction to the Forfaiting bank.
 Exporter endorses avalised Bill of Exchange (BOE) with
the words “Without re­course” and forwards them to the
Forfaiting Agency (FA) through his bank.
 The FA effects payments of discounted value after
verifying the Aval’s signature and other particulars.
 Exporter’s Bank credits Exporter’s a/c.
 On maturity of BOE/Promissory notes, the Forfaiting
Agency presents the instruments to the Aval (Importer’s
Bank) for payment.
Loan syndication:

 Loan syndication is the process of involving a group

of lenders in funding various portions of a loan for a
single borrower. Loan syndication most often occurs
when a borrower requires an amount too large for a
single lender to provide or when the loan is outside
the scope of a lender's risk-exposure levels. Thus,
multiple lenders form a syndicate to provide the
borrower with the requested capital.
 The agreements between lending parties and loan
recipient often need to be managed by a corporate
risk manager
Loan syndication:

 PARTIES INVOLVED IN A SYNDICATED LOAN

TRANSACTION
 Borrower – Requirement of capital for expansion
project or acquisition transaction. The borrower is
responsible for loan and interest repayment
 Investment Bankers – Act as a facilitator in the loan
transaction.
 Lead Bank – Responsible for structuring the loan
transaction.
 Participating Banks – Lend some % of the total loan
amount.
Consumer credit:

 Consumer credit is personal debt taken on to

purchase goods and services. A credit card is
one form of consumer credit.
  the term is usually used to describe
unsecured debt that is taken on to buy
everyday goods and services. 
Advantages:

 Easy to buy goods and services

 Buy even with low cash
 Gets advance
Dis advantages:

 Cost is high
 If failed to pay,penalties
Types:

 Installment credit:for defined amount and

period. Like purchase of machinery.
 Non installment credit:for short term,like
departmental stores offer such credit to
regular customers
 Revolving credit:when limit is extended to a
customer dependingupon his past
pweformance of credit history and how he
can deal with debts.
Challenges facing financial
services:
 Cyber crime in finance
 Ever changing regulations
  Big Data Use In Finance
 Growth of companies with low cost
 Customer satisfaction
 Data security
 Huge competition
 Customer retention
 Providing them to enjoy good profits
Challenges facing financial
services:
 Increase in revenue
 Dynamic changes in technology
 https://www.rentalpha.com/why-lease/case-s
tudies/