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Financial Management and Business Data Analytics · Financing Working Capital

Short-Term Instruments and Factoring for CMA Intermediate

Updated 10 October 2026 · Fact-checked

Short-term instruments raise cash for days or months. Commercial paper and certificates of deposit are money market instruments sold at a discount. Factoring sells trade receivables to a factor for immediate cash. Forfaiting sells medium-term export receivables without recourse. To solve, compute net proceeds, then the annualised cost: charges ÷ net proceeds × 365 ÷ days.

Understand Short-Term Instruments and Factoring

Businesses need cash between making a sale and collecting from the customer. Short-term instruments bridge that gap. Some tap the money market directly, such as commercial paper. Others convert receivables into cash, such as factoring and forfaiting.

Commercial paper (CP) is an unsecured, short-term promissory note issued by a creditworthy company. It is issued at a discount to face value and redeemed at face value. The difference is the interest. The company also pays costs such as the issuing and paying agent fee and the credit rating fee, so the true cost is higher than the discount rate. Under RBI directions, the usual maturity range is 7 days to 1 year. Check the latest figures in your study material.

Certificate of deposit (CD) is a negotiable deposit instrument issued by banks and some financial institutions. It is also issued at a discount. A CD is a source of funds for the bank, not for an ordinary company. Companies and investors buy CDs to park surplus cash.

Factoring is the sale of trade receivables to a financial institution, the factor. The factor usually advances a percentage of invoice value, collects from the customer, and may also keep the sales ledger and cover bad debts. In recourse factoring, the client bears bad debt loss. In non-recourse factoring, the factor bears it, so the commission is higher. Other types you should know are advance and maturity factoring, disclosed and undisclosed factoring, domestic and export factoring, and supplier-guaranteed factoring. In India, the Factoring Regulation Act, 2011 and RBI rules govern factoring, with NBFC-Factors as the main providers.

Forfaiting is the purchase, without recourse to the exporter, of medium-term export receivables, usually backed by bills of exchange or promissory notes that are often guaranteed by a bank. The exporter gets cash at once, and the forfaiter takes the country and credit risk. Factoring suits short-term, high-volume, open-account sales. Forfaiting suits large, single, medium-term export deals.

Key rules to remember

Commercial paper discount
Discount = Face value × Discount rate × Days ÷ 365
Net proceeds = Face value − Discount. Use 365 days unless the question says otherwise.
Effective annual cost of CP (simple)
Cost = (Total cost ÷ Net amount received) × (365 ÷ Days)
Total cost = discount + issue expenses such as rating, IPA and stamp charges. Use net amount received after all costs.
Effective annual cost of CP (compounded)
Effective rate = (1 + Cost for the period ÷ Net amount)^(365 ÷ Days) − 1
Use only if the question asks for the effective or compounded rate.
Factor advance
Gross advance = Invoice value × Advance %; Interest = Gross advance × Rate × Credit period ÷ 365; Net advance received = Gross advance − Commission − Interest
Commission is charged on invoice value. Interest is calculated on the gross advance (before deductions) for the credit period. Read the question for what is deducted upfront.
Cost of factoring (annual)
Cost % = (Commission + Interest) ÷ Net advance received × (365 ÷ Credit period)
Compare with the benefits saved: collection costs, bad debts (non-recourse) and interest on funds freed.
Net benefit of factoring
Net benefit = Savings (admin cost + bad debts avoided + interest on freed funds) − Factoring cost
Accept factoring if net benefit is positive or the effective cost is below the alternative borrowing rate.

How to solve Short-Term Instruments and Factoring questions

Use this order for any numerical on commercial paper, CDs, factoring or forfaiting. It keeps the layout clear for step marks.

  1. 1Identify the instrument and what the company receives: face value, invoice value or bill amount, and the period in days.
  2. 2Write the amount received at the start. For CP, face value less discount. For factoring, advance % of invoice less commission and interest.
  3. 3List every cost: discount, commission, interest, rating or agent fees. Keep them separate.
  4. 4Compute the cost for the period as a percentage of the net amount actually received, not of the face value.
  5. 5Annualise using 365 ÷ days, or compound if asked for the effective rate.
  6. 6If it is a factoring decision, add the savings (admin cost, bad debts, interest on funds freed) and find net benefit or compare the effective cost with bank borrowing.
  7. 7State the decision in one line and give the reason. For recourse versus non-recourse, mention who bears the bad debt risk.

Quickest way: Net proceeds, then period cost, then annualise

When to use it: Use this for MCQs and short numericals on CP cost and factoring cost where options are close in value.

  1. Take the net amount received as the base. Never use face value as the base.
  2. Period cost % = total charges ÷ net amount.
  3. Multiply by 365 ÷ days. For 90 days, the multiplier is about 4.06.
  4. For factoring, compute commission and interest on the right base: commission on invoice, interest on advance.
  5. Sense-check: the annual cost should be a little above the quoted discount rate for CP, because of the lower base and extra fees.

Common mistakes in Short-Term Instruments and Factoring

  • Using face value as the denominator in the cost of commercial paper.

    Students divide the discount by face value, which gives the discount rate, not the true cost.

    Fix: Divide total cost by the net amount actually received, then annualise.

  • Leaving out issue expenses such as rating, IPA and stamp fees from the CP cost.

    The question lists them in a separate line and students focus only on the discount.

    Fix: Add all costs to the discount before dividing by net proceeds.

  • Charging factor interest on the full invoice value instead of the advance.

    Students treat the invoice as the amount financed.

    Fix: Interest runs only on the amount advanced. Commission runs on the invoice value.

  • Mixing up recourse and non-recourse.

    Both are described as selling receivables, so the risk transfer gets forgotten.

    Fix: Recourse: the client repays the factor if the customer defaults. Non-recourse: the factor absorbs the loss, so the commission is higher.

  • Writing that forfaiting and factoring are the same because both sell receivables.

    Short definitions look alike.

    Fix: Compare on term, nature of trade, recourse, and security. Factoring is short-term, usually domestic and often with recourse. Forfaiting is medium-term, export-based and without recourse.

  • Ignoring savings in a factoring decision and only quoting the cost.

    Students stop after computing the effective cost.

    Fix: Add savings from lower administration, avoided bad debts and interest on funds released, then give the net benefit.

Worked examples

Example 1

A company issues commercial paper of face value ₹5,00,00,000 for 90 days at a discount rate of 8% per annum. Issue expenses (rating, IPA and stamp) total ₹2,50,000. Compute the effective annual cost, using 365 days and simple annualisation.

Show the solution
  1. Discount = 5,00,00,000 × 8% × 90 ÷ 365 = ₹9,86,301 (rounded).
  2. Net proceeds before expenses = 5,00,00,000 − 9,86,301 = ₹4,90,13,699.
  3. Net amount received after expenses = 4,90,13,699 − 2,50,000 = ₹4,87,63,699.
  4. Total cost = 9,86,301 + 2,50,000 = ₹12,36,301.
  5. Cost for 90 days = 12,36,301 ÷ 4,87,63,699 = 2.535%.
  6. Annualised = 2.535% × 365 ÷ 90 = 10.28%.

Answer: The effective annual cost is about 10.28%, which is higher than the 8% discount rate because of the lower base and the issue expenses.

Example 2

Sundaram Textiles has credit sales of ₹3,65,00,000 a year, collected in 60 days on average. A factor offers to take over the receivables on a without-recourse basis: commission 2% of invoice value, advance of 80% of invoice, and interest at 12% p.a. on the advance. The company will save administration costs of ₹3,00,000 a year and bad debts of 1% of sales. The funds released will replace bank borrowing that costs 12% p.a., so interest saved equals 12% on the advance. Use 365 days and assume sales are spread evenly. Find the net annual benefit or cost of factoring.

Show the solution
  1. Average receivables = 3,65,00,000 × 60 ÷ 365 = ₹60,00,000.
  2. Factoring commission = 2% of sales = ₹7,30,000 a year.
  3. Advance = 80% × 60,00,000 = ₹48,00,000. Interest charged by the factor = 48,00,000 × 12% = ₹5,76,000 a year.
  4. Total cost of factoring = 7,30,000 + 5,76,000 = ₹13,06,000.
  5. Savings: administration ₹3,00,000 + bad debts 1% × 3,65,00,000 = ₹3,65,000 + interest saved on freed funds 48,00,000 × 12% = ₹5,76,000. Total savings = ₹12,41,000.
  6. Net cost = 13,06,000 − 12,41,000 = ₹65,000.

Answer: Factoring has a net cost of ₹65,000 a year, so it is not beneficial on these figures. The assumption that the advance replaces 12% borrowing should be stated in your answer.

Exam tips

  • For MCQs on CP cost, remember the true cost is above the quoted discount rate. Eliminate options below the discount rate.
  • In theory questions, answer factoring versus forfaiting as a four-row comparison: nature, term, recourse, security.
  • State the assumptions you use, such as 365 days, even sales, and what the advance replaces. Examiners give step marks for stated assumptions.
  • Always show net proceeds as a separate line before computing cost.
  • Name the type of factoring in your answer: recourse or non-recourse, advance or maturity, disclosed or undisclosed.

Practice questions from Financing Working Capital

Short-Term Instruments and Factoring in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Short-Term Instruments and Factoring: frequently asked questions

What is the difference between factoring and forfaiting?

Factoring deals with short-term trade receivables, mostly domestic, and can be with or without recourse. Forfaiting deals with medium-term export receivables and is always without recourse to the exporter. Forfaiting usually involves a bank guarantee on the bills.

How do you calculate the cost of commercial paper?

Find the discount and add issue expenses. Divide the total by the net amount received. Multiply by 365 ÷ days. This gives the annual cost, which is above the quoted discount rate.

What is factoring with recourse and without recourse?

With recourse, the client must repay the factor if the customer does not pay. Without recourse, the factor takes the bad debt loss. Without recourse costs more because the factor takes the credit risk.

What are the types of factoring in India?

Common types are recourse and non-recourse, advance and maturity, disclosed and undisclosed, and domestic and export factoring. Your study material may add others such as supplier-guaranteed factoring. Learn the one-line meaning of each.